Rating action

Scope Ratings GmbH (Scope) has today affirmed the European Financial Stability Facility (EFSF)’s AA+ long-term issuer and senior unsecured foreign-currency ratings, along with the short-term issuer rating of S-1+ in foreign currency. All Outlooks are Stable.

For the detailed rating report, click here.

Summary and Outlook

Scope’s AA+ rating of the EFSF reflects the supranational’s highly rated key shareholders, strong guarantee mechanism and excellent capital market access. However, the EFSF’s mandate to lend to crisis-hit countries and its lack of preferred creditor status result in moderate asset quality, and its shareholder base is highly concentrated.

The Stable Outlook reflects Scope’s assessment that risks are broadly balanced.

The ratings/Outlooks could be downgraded if, individually or collectively: i) key shareholders were downgraded; ii) the cash buffer decreased significantly; and/or iii) access to capital markets was meaningfully impaired. The ratings/Outlooks could be upgraded if, individually or collectively: i) key shareholders were upgraded; and/or ii) the EFSF’s liquidity buffers increased significantly and permanently.

Rating rationale

The first driver underpinning the EFSF’s AA+ rating is its highly rated key shareholders.

While the EFSF does not have any meaningful capital, 13 eurozone member states provide irrevocable, unconditional, timely guarantees and over-guarantees for the EFSF’s debt issuances. The four largest euro area economies – Germany (AAA/Stable), France (AA/Stable), Italy (BBB+/Negative) and Spain (A-/Stable) – jointly guarantee 83% of the EFSF’s liabilities, providing them with significant control in the decision-making bodies. These four sovereigns thus constitute the EFSF’s key shareholders, with a weighted-average rating of AA-.

The sovereign credit ratings of the EFSF’s largest shareholders have been stable in recent years. A one-notch downgrade for any one of the main shareholders would not result in a change to the average key shareholder rating. For this to fall by one notch to A+, the sovereign ratings of two key shareholders would have to be downgraded by one notch. More widespread sovereign downgrades would need to occur before the resulting decline in shareholder support could cause a downgrade for the EFSF. Even in a scenario where all four key shareholders face a one-notch downgrade, the EFSF’s final rating would remain stable.

The second driver underpinning the EFSF’s AA+ rating is its robust institutional setup, including the strong guarantee mechanism.

The guarantee framework is highly credible because a failure to honour the guarantees would sharply lower market confidence in euro area sovereigns’ commitment to other European institutions, particularly the European Stability Mechanism (ESM). The strong institutional setup includes an over-guarantee mechanism of up to 165% of the EFSF’s outstanding securities, resulting in guarantees of EUR 724bn for a maximum lending capacity of EUR 440bn. As of July 2013, the EFSF can no longer engage in new financial assistance facilities. But it has continued to manage existing programmes in Greece, Portugal and Ireland, including the repayment of outstanding debts. Based on Scope’s sovereign ratings, adjusting the shares of EFSF shareholders for the over-guarantee mechanism results in 100% coverage of EFSF debt issuances by sovereigns rated AA or above. Specifically, guarantee commitments from AAA to AA rated sovereigns – Germany (48.0%), France (36.0%), the Netherlands (10.1%), Austria (4.9%), Finland (3.2%) and Luxembourg (0.4%) – jointly cover 102.6% of the EFSF’s maximum lending capacity. Scope’s analysis acknowledges the strength of the over-guarantee mechanism by adjusting the key shareholder rating upwards by one notch.

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

The third driver supporting the EFSF’s AA+ rating is its strong capital market access.

EFSF issuances are designated as Level 1 high-quality liquid assets and granted a 0% risk weighting under the Basel framework. They are also 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 June 2022, or about EUR 111bn, which is just over one-third of the total outstanding debt issued by both institutions. This preferential regulatory treatment, along with guarantees from its highly rated shareholders, has allowed the EFSF to build a record of raising significant volumes (notably, EUR 58bn in 2013 and EUR 49bn in 2017) and a strong, well-diversified funding base².

As the EFSF no longer engages in new programmes, financing existing loans results in predictable funding needs that will decline gradually in upcoming years. Outstanding debt securities amounted to about EUR 195.5bn as at Q2 2022, and annual funding needs are projected at around EUR 19.5bn in 2022 and EUR 20.0bn in 2023. The EFSF has a proven ability to issue across the yield curve by using various instruments with very long maturities and relatively low funding costs. This 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 nine years.

Finally, the EFSF’s funding flexibility allows it to raise its cash buffer (as it did between 2017 and 2019), which can lower liquidity risks. However, Scope notes that the EFSF’s liquid assets, including cash and cash equivalents and highly rated treasury assets, have decreased from about EUR 8.6bn in 2020 to EUR 2.6bn in 2021, more than halving its coverage of liabilities due within one year from around 36% to 16%³. This drop is driven by a EUR 4.5bn decline in cash and cash equivalents and a EUR 1.5bn decline in treasury financial assets. The lower level of cash is due to outflows related to the return of prepaid margin to beneficiary member states and the issuance of debt instruments. It was partially offset by a EUR 0.8bn increase in loans to euro area member states, mostly driven by additional deferred interest on loans to Greece.

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

First, while it benefits from guarantees and over-guarantees from highly rated shareholders, its shareholder base is highly concentrated compared to other supranationals. This increases its dependence on any one shareholder’s ability to honour guarantees if called. That being said, Scope has no doubt that shareholders would be willing to honour any guarantee call should one 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. Although it stopped financing new programmes in July 2013, it has continued to finance existing ones until all outstanding bonds and loans are repaid: EUR 130.9bn is owed by Greece (BB+/Stable), EUR 24bn by Portugal (BBB+/Stable) and EUR 17.7bn by Ireland (AA-/Stable). The weighted average borrower quality has improved in recent years from B+ in 2017 to BBB- in 2021. In line with its mandate, the EFSF demonstrates flexibility to reprofile loans to reduce interest and defer amortisation payments to ease repayment pressure on its borrowers. This enhances their creditworthiness and, in turn, reduces the credit risk of the EFSF’s own portfolio. The first scheduled principal repayments are in 2023 for Greece, 2025 for Portugal, and 2029 for 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 do. Its debt securities thus rank pari passu with those of private creditors.

Factoring of environment, social and governance (ESG)

Scope considers ESG sustainability issues during the rating process as reflected in its supranational methodology. ESG factors are explicitly captured in Scope’s assessment of the institutional profile, which Scope assesses as ‘moderate’ for the EFSF. Environmental factors were not considered during the issuance of the EFSF’s financial assistance.

Scope’s supranational scorecard

Scope’s supranational scorecard, which is based on clearly defined quantitative parameters, provides an indicative AA+ rating for the EFSF. 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.

No adjustment was made to the EFSF’s indicative rating.

A rating committee has discussed and confirmed these results.

For further details, please see Appendix II of the rating report.

Rating committee
The main points discussed were: i) shareholder support; ii) institutional profile; iii) financial profile, including the guarantee framework, asset quality, liquidity and funding; iv) additional considerations; and v) consideration of peers.

Rating driver references
1. EFSF Framework Agreement 
2. EFSF/ESM Investor Relations Presentation June 2022
3. EFSF Annual Accounts

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Rating Methodology:Supranational Entities, 7 September 2021), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit 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 Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Eiko Sievert, Director
Person responsible for approval of the Credit Ratings: Dr Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 8 May 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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