30 November 2012

Moody's downgrades ESM to Aa1 from Aaa and EFSF to (P)Aa1 from (P)Aaa, maintains negative outlook on ratings

Moody's decision was driven by the recent downgrade of France to Aa1 from Aaa and the high correlation in credit risk which Moody's believes is present among the ESFS' and ESM's entities' largest financial supporters.

Moody's downgrade of France reflects the rating agency's view that there has been a marginal diminution in the certainty that the sovereign will fulfil its financial obligations. France is the second largest contributor to the two entities' financial resources, as a provider of callable capital in the case of the ESM and as a guarantor country in the case of the EFSF.

Moody's view that there is a high correlation in credit risk among the entities' supporters is consistent with the evolution to date of the euro area debt crisis and the close institutional, economic and financial linkages among the major euro area sovereigns. As a result, the credit risks and ratings of the ESM and the EFSF are closely aligned to those of its strongest supporters.

At the same time, Moody's explains that both entities remain extremely highly rated at Aa1 because the ESM and the EFSF benefit from the following common credit strengths:

(i) Low leverage: the ESM has a maximum lending capacity of €500 billion, which is backed by subscribed capital of €700 billion; while the EFSF has a guarantee mechanism which results in an overcollateralisation of up to 165 per cent; and

(ii) The creditworthiness of the members: both entities have a weighted median shareholder rating of Aa1 (changed from Aaa further to the downgrade of France's government bond rating to Aa1); both the ESM's and the EFSF's purpose is to provide an inter-governmental support mechanism which extends financial assistance to members that are either unable to access the capital markets, or able to do so only at very high interest rates.

Moody's acknowledges that the ESM benefits from credit features that differentiate it from the EFSF, including the preferred creditor status and the paid-in capital of €80 billion. However, in Moody's view, these credit features do not enhance the ESM's credit profile to the extent that it would warrant a rating differentiation between the two entities.

In a related rating action, Moody's has additionally downgraded the ratings on all the debt securities that have been drawn down to date from the EFSF to Aa1 from Aaa. A provisional rating for a debt facility is an indication of the rating that Moody's would likely assign to future draw-downs from the facility, pending the receipt of documentation detailing the terms of the debt issuance.

The decision met with some controversy. "Credit rating agencies will have to be more transparent when rating sovereign states, respect timing rules on sovereign ratings, and justify the timing of publication of unsolicited ratings of sovereign debt", said financial services commissioner Michel Barnier. Klaus Regling, who chairs the ESM as well as the EFSF, said: "We disagree with the rating agency's approach which does not sufficiently acknowledge ESM's exceptionally strong institutional framework, political commitment and capital structure".

During a conference in Paris on Friday, ECB chief Mario Draghi said that the downgrade would have little effect but that it was a "signal to be taken seriously".

Press release

See also ESM/EFSF-statement following Moody's rating decision

© Moody's