- The concluding statement of the European Council meeting of March 24-25, 2011, confirms our previously published expectations that (i) sovereign debt restructuring is a potential pre-condition to borrowing from the European Stability Mechanism (ESM), and (ii) senior unsecured government debt will be subordinated to ESM loans.
- Both features are, in our view, detrimental to the commercial creditors of EU sovereign ESM borrowers, and represent a major departure from the current European Financial Stability Facility (EFSF) regime whereby sovereign EFSF loans rank pari passu with a borrowing sovereign's commercial debt.
- It is our view that Ireland, which is currently accessing the EFSF, might also borrow from the ESM.
- We are therefore lowering our sovereign credit ratings on the Republic of Ireland to 'BBB+/A-2'.
- At the same time, we have removed the ratings on Ireland from CreditWatch, where they were placed with negative implications on Nov. 23, 2010.
- The outlook on the ratings is now stable, reflecting our opinion of the credibility of the stress tests conducted by the Central Bank of Ireland to determine additional capital needs for the Irish banking system.
- The projected €18-€19 billion (11.5%-12.0% of GDP) net cost to the Irish state of additional recapitalization for the banking system is within our range of expectations, albeit at the upper end.
On April 1, 2011, Standard & Poor's Ratings Services lowered its sovereign credit ratings on the Republic of Ireland to 'BBB+/A-2'. At the same time, we removed the ratings from CreditWatch, where they were placed with negative implications on Nov. 23, 2010. The outlook is stable.
The downgrade to 'BBB+' and the outlook action applies to other ratings that depend on Ireland's sovereign credit rating, including the issuer credit rating on the National Asset Management Agency (NAMA), and the senior unsecured debt ratings on government-guaranteed securities of Irish banks.
The downgrade reflects our view of the concluding statement of the European Council (EC) meeting of March 24-25, 2011, that confirms our previously published expectations that (i) sovereign debt restructuring is a possible pre-condition to borrowing from the European Stability Mechanism (ESM), and (ii) senior unsecured government debt will be subordinated to ESM loans. Both features are, in our view, detrimental to the commercial creditors of EU sovereign ESM borrowers.
The EC's concluding statement addresses the issues of sovereign debt restructuring and government bond subordination in items 1 and 3 of the ESM's term sheet.
According to the EC's concluding statement: "If, on the basis of a sustainability analysis, it is concluded that a macro-economic program cannot realistically restore the public debt to a sustainable path, the beneficiary Member State will be required to engage in active negotiations in good faith with its creditors to secure their direct involvement in restoring debt sustainability. The granting of the financial assistance will be contingent on the Member State having a credible plan and demonstrating sufficient commitment to ensure adequate and proportionate private sector involvement."
"Like the IMF, the ESM will provide financial assistance to a Member State when its regular access to market financing is impaired. Reflecting this, Heads of State or Government have stated that the ESM will enjoy preferred creditor status in a similar fashion to the IMF, while accepting preferred creditor status of IMF over ESM."
We have removed the ratings on Ireland from CreditWatch, where they were placed with negative implications on Nov. 23, 2010. The outlook is now stable, reflecting our opinion that the assumptions underlying the stress test (The Financial Measures Programme, comprising Prudential Capital Assessment and Prudential Liquidity Assessment Reviews) conducted by the Central Bank of Ireland--in conjunction with the IMF, European Central Bank (ECB), and European Commission--are robust and that the expected €18-€19 billion (11.5%-12.0% of GDP) net cost to the Irish state of additional recapitalization, plus the contingency buffer for the banking system, is within our range of expectations, albeit at the upper end.
Of this net cost, we understand that €10 billion will be funded by a contribution from the National Pensions Reserve Fund, while the remainder will be financed via €7 billion in cash balances at the Treasury, implying a €1-€2 billion (0.6%-1.0% of GDP) increase in gross debt. This would still leave an estimated €9 billion (5.6% of GDP) in cash balances at the Treasury.
Our understanding is that the anticipated gross cost of the state's further participation in the financial system would be €23.8 billion (15% of GDP) of which €3 billion is a contingency. The outcome of the Prudential Capital
Assessment and Prudential Liquidity Assessment Reviews stress tests does not include, however, any discount for tax-loss carryforwards of the Irish banking system, which we anticipate are equivalent to less than 2% of GDP. We consider that tax-loss carryforwards have weak capacity to absorb losses.
Standard & Poor's is of the opinion that the sharp contraction in Ireland's nominal GDP and gross national product since 2008 has reached an end, and that the Irish economy is now set to gradually recover. We believe that the Irish economy has stronger growth prospects than the Portuguese and Greek economies considering its openness (Ireland's exports are forecast at 107% of GDP for 2011 compared with Portugal's 30% of GDP), its flexibility, and its competitiveness. We anticipate that Ireland's current account will post a full-year surplus of more than 2% of GDP during 2011, for the first time since 2003, while net exports will continue to be the major contributor to headline GDP performance.
Standard & Poor's expects that Ireland's emergency liquidity assistance advance of €65 billion will gradually be repaid with proceeds from the disposal of non-core assets of Irish banks as part of the deleveraging process. That said, we also anticipate that the repayment of €88.7 billion in ECB advances to domestic credit institutions will be more difficult to achieve during the lifetime of the EU-IMF Extended Fund Facility Arrangement, which
expires in December 2013. In our view, despite the announced capital injections, the Irish banking system's liquidity position remains weak and we do not expect that its earnings prospects will recover any time soon.
The stable outlook reflects our view of the balanced risks to Ireland's creditworthiness. Were the financial system to require additional material capital contributions from the state or were the Irish government to significantly fall short of its ambitious fiscal targets, the rating could come under downward pressure. Alternatively, were the government to raise more than 10% of GDP from the sale of National Asset Management Agency (NAMA) assets more rapidly than we currently anticipate, or were the economy to return more quickly to average growth rates above our current expectations of 2.0%-2.5%, we could consider raising the ratings.