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.

Scope’s affirmation of the EFSF’s AA+ rating reflects the supranational’s highly rated key shareholders, strong guarantee mechanism and favourable capital market access, with 75% of the EUR 20bn long-term funding programme completed to date. Rating challenges include the EFSF’s mandate to lend to euro area crisis-hit countries and its lack of preferred creditor status, which results in moderate asset quality, as well as the entity’s highly concentrated shareholder base.

For the rating report, click here.

Key rating drivers

Highly rated key shareholders

While the EFSF does not have any meaningful capital, 13 euro area 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/Negative), Italy (BBB+/Stable) and Spain (A-/Positive) – 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, nor would it result in a change to the EFSF’s final rating. Still, in the case of a one-notch sovereign rating downgrade of France (AA/Negative), Scope’s assessment of the strength of the EFSF’s over-guarantee mechanism would weaken, which is based on the coverage of liabilities via over-guarantees from shareholders rated AA or higher. In that case, Scope would no longer provide an uplift for the over-guarantee mechanism, which in itself would not change the rating of the EFSF.

However, in the scenario, in which France were to be rated AA- and no benefit would apply to the over-guarantee mechanism, an additional one-notch downgrade of either Germany, Italy or France would lead, all other things equal, to a lower average key shareholder rating of A+ and therefore a one-notch downgrade of the EFSF’s long-term rating. Conversely, if France, Italy and Spain were upgraded by one notch each, it would lead to an upgrade of the EFSF’s credit rating, all other things equal.

Robust institutional setup, including the strong guarantee mechanism

The EFSF’s 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, rated AAA/Stable). 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. However, the EFSF continues 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 issuance 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.

Favourable capital market access

EFSF issuances are designated as Level 1 high-quality liquid assets, granted a 0% risk weighting under the Basel framework and are included in several SSA and government bond indices. This preferential regulatory treatment, along with guarantees from its highly rated shareholders, has allowed the EFSF to raise significant volumes in the past (notably, EUR 58bn in 2013 and EUR 49bn in 2017) from a strong, well-diversified investor base of the ESM and EFSF, including banks (39% of issuances in 2023), fund managers (30%) as well as pension funds and insurers (5%)².

As the EFSF no longer engages in new programmes, financing existing loans results in predictable funding needs that will decline gradually over time. Outstanding debt securities amounted to about EUR 190.4bn as at end-2023, and annual funding needs are projected at around EUR 20bn in 2024 and EUR 21.5bn in 2025. 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 8.8 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. Scope notes that the EFSF’s liquid assets, including cash and cash equivalents and highly rated treasury assets, have increased from about EUR 2.6bn in 2021 to EUR 5.5bn in 2023, thereby significantly increasing its coverage of liabilities due within one year from around 16% to 21%³. This brings the EFSF’s liquid asset ratio broadly in line with the historic average following a significant decline in 2021.

Rating challenges: concentrated shareholder base, mandate to lend to crisis-hit countries, no preferred creditor status

First, while the EFSF 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 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 127.8bn is owed by Greece (BBB-/Positive), EUR 24bn by Portugal (A-/Stable) and EUR 17.7bn by Ireland (AA-/Positive). Driven by recent credit upgrades, the weighted average borrower quality has improved in recent years from B+ in 2017 to BBB. 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 the creditworthiness of borrowers and, in turn, reduces the credit risk of the EFSF’s own portfolio. Repayments on outstanding loans by the EFSF’s three borrowers stretch over a long period with Portugal expected to make its scheduled repayments from 2025 to 2040, Ireland from 2029 to 2042 and Greece from 2023 to 2070. The first scheduled repayment of EUR 1.7bn was received from Greece in 2023.

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.

Outlook and rating sensitivities

The Stable Outlook reflects Scope’s opinion that risks to the credit ratings over the next 12 to 18 months are broadly balanced.

A downside scenario for the ratings and Outlooks is:

1. Several key shareholders were downgraded.

Upside scenarios for the ratings and Outlooks are (individually or collectively):

1. Key shareholders were upgraded; and/or
    
2. The EFSF’s liquidity buffers increased significantly and permanently.

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 ‘Adequate’ for the EFSF, and the assessment of potential climate risks under the portfolio quality.

Scope’s supranational scorecard

Scope’s supranational scorecard, which is based on clearly defined quantitative parameters, provides an indicative ‘aaa/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 indicative rating of the EFSF.

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 July 2024 
3. EFSF Annual Accounts 

Methodology
The methodology used for these Credit Ratings and Outlooks, (Supranational Rating Methodology, 21 June 2024), 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 Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings and Outlooks were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Eiko Sievert, Senior Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 8 May 2020. The Credit Ratings/Outlooks were last updated on 21 July 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis 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.