European Rescue Mechanism Loses AAA Rating
S&P futures are bleeding back down again after-hours (and EUR -30pips) as Moody's announces the downgrade of the EFSF and ESM from AAA to Aa1. "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." Of course, this is nothing to worry about as we are sure that some Middle East sovereign wealth fund will still buy their bonds? Or China? Or Supervalu?
- *MOODY'S DOWNGRADES ESM TO Aa1 FROM Aaa, EFSF TO (P)Aa1 FROM Aaa
Not entirely surprising given the underlying rating moves - but yet more AAA-rated collateral bites the dust.
Full statement to follow:
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 EUR500 billion, which is backed by subscribed capital of EUR700 billion; while the EFSF has a guarantee mechanism which results in an overcollateralisation of up to 165%; 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 EUR80 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.
Hence, the combination of France's large ESM capital share and the elevated default correlation of euro area member states leads to the conclusion that, in such a scenario, the effectively accessible capital -- subscribed capital of EUR700 billion minus the callable capital of defaulting countries -- will likely fall short of covering the outstanding issuance. Accordingly, in light of its anticipated highly concentrated credit portfolio and the high correlation of euro area member states' creditworthiness, Moody's considers the ESM's rating to be currently constrained by France's government bond rating.
Similarly to the ESM, the one-notch downgrade of the EFSF's rating to Aa1 from Aaa follows the recent downgrade of France's government bond rating to Aa1 from Aaa. France's share in the EFSF contribution key is 21.8%, second after Germany's 29.1% share. France's share corresponds to a guarantee commitment of EUR158 billion (out of EFSF's total guarantee commitment of EUR726 billion). Further to France's loss of its Aaa rating, only 67% instead of the previous 100% of the EFSF issuances are now backed by guarantees issued by Aaa-rated sovereigns. The full coverage of EFSF issuances by guarantees issued by Aaa-rated sovereigns had been a key factor for the EFSF's Aaa.
In the very unlikely scenario of the French sovereign bond default, Moody's does not expect that France would be able to fund its commitments to the EFSF. Furthermore, given the credit risk correlation of the EFSF guarantor countries, Moody's considers it unlikely that lower-rated member states would be in a position to honour their own commitments to the EFSF and fully compensate for a potential shortfall arising from France. Hence, in light of the elevated credit risk correlation among the guarantor countries, the EFSF's rating is -- similar to that of the ESM -- currently constrained by France's government bond rating.
RATIONALE FOR NEGATIVE OUTLOOK
The negative outlook on the ESM's long-term rating reflects the negative outlooks on the ESM member states with significant capital contribution keys and high ratings. Specifically, the Aaa ratings of Germany (which holds a 27.1% share in the subscribed capital) and the Netherlands (5.7%), as well as the Aa1 rating of France (20.4%) all have negative outlooks.
The negative outlook on the EFSF's (P)Aa1 rating reflects the negative outlooks on euro area sovereigns that are EFSF guarantors, including some countries with significant shares in the EFSF's guarantor pool. Specifically, the Aaa ratings of Germany (which holds a 29.1% share in the guarantor pool) and the Netherlands (6.1%), as well as the Aa1 rating of France (21.8%) all have negative outlooks.
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