Frankfurt am Main, December 06, 2012
Moody’s Investors Service has today assigned a provisional (P)Aa1 long-term rating and a provisional (P)Prime-1 short-term rating to the debt issuance programme of the European Stability Mechanism (ESM), in line with the ESM’s issuer ratings of Aa1 and Prime-1.
The outlook on the long-term programme rating is negative, in line with the outlook on the long-term issuer rating. Notes issued under the programme will constitute senior unsecured direct and unconditional obligations of the issuer.
The (P)Aa1/(P)Prime-1 ratings are based on the following factors:
- The ESM’s anticipated low leverage: the ESM has a maximum lending capacity of EUR500 billion, which is backed by subscribed capital of EUR700 billion.
- The creditworthiness of the ESM’s members which are also the euro area member states: the ESM has a weighted median shareholder rating of Aa1 (changed from Aaa further to the downgrade of France’s government bond rating to Aa1).
- The sound liquidity and capital management policy, which benefits from an Early Warning System (EWS) that ensures that funds will be available on time.
- The ESM’s preferred creditor status.
The ESM’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.
The first key rating factor underlying Moody’s decision to assign a (P)Aa1/(P)P-1 ratings to the ESM debt issuance programme relates to its anticipated low leverage. The ESM has a lending capacity (both loans extended to and purchases of securities issued by supported member states) of EUR500 billion and subscribed capital of EUR700 billion (consisting of EUR80 billion of paid-in capital and EUR620 billion of callable capital). If the ESM’s capital is reduced (e.g., due to losses resulting from a borrower default), the leverage ratio — defined as lending capacity/subscribed capital which must not exceed 71% — would automatically limit the lending capacity and thereby stabilise the structure of the ESM funding.
The second key rating factor underpinning the (P)Aa1/(P) P-1 ratings is that the ESM’s shareholders are the euro area’s member states, which provide capital to the ESM according to the same capital key that is applied to the European Central Bank (ECB). The ESM therefore benefits from the very high credit quality of its shareholders and the very high likelihood that they will be able to comply with their capital-related obligations. The current capital key-weighted median rating is Aa1, given that the two main member states in terms of their capital contribution, Germany and France, hold a Aaa rating and a Aa1 rating, respectively.
The third key rating factor underlying the provisional ratings assigned today is the ESM’s strong liquidity and capital management policy. A credit-enhancing feature is the ESM’s Early Warning System (EWS) which, by providing an assessment of borrowers’ repayment capacity well in advance of the repayment date, ensures that capital calls can be made and implemented well in advance of any payment shortfall. The ESM Treaty places a legal obligation on the ESM’s Managing Director to call capital if needed, without requiring approval by the Board of Governors or the Board of Directors. With respect to its capital management policy, the ESM invests in liquid Aa2 or higher rated instruments, mainly government securities or equivalent.
The fourth key rating factor is the ESM’s preferred creditor status that is junior only to that of the International Monetary Fund (IMF). This status differentiates the ESM from its predecessor entity, the European Financial Stability Facility (EFSF), which ranks pari-passu with senior unsecured bondholders.
RATIONALE FOR NEGATIVE OUTLOOK
The negative outlook on the ESM’s provisional long-term rating reflects the negative outlooks on the ESM member states that have 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.
WHAT COULD MOVE RATINGS UP/DOWN
Risks that would negatively affect the creditworthiness of the ESM — leading to a potential downgrade of the ESM’s provisional debt ratings — would include a deterioration in the creditworthiness of the participating euro area member states (as reflected by a change in Moody’s ratings for these states). In this context, the ESM’s rating is sensitive to changes in the ratings of Aaa- and Aa-rated countries with large ESM capital contribution keys, i.e., Germany, France and the Netherlands.
Furthermore, a weakening of the political commitment among euro area member states to the ESM could also have negative rating implications. Also, given that the ESM’s rating is based on the assumption of superior financial-management capabilities, transition/downgrade risks could also arise from a potential erosion of those capabilities. Such risks would arise in the event of an inappropriate skill transfer or skill acquisition that might adversely affect ESM’s governance and risk management practice.
Given that the outlook on the ESM’s provisional long-term debt rating is currently negative, the rating is unlikely to experience upward pressure in the near term. However, Moody’s could change the outlook for the ESM’s provisional long-term debt rating to stable if the outlooks on the ratings of the highly rated countries that are key capital contributors to the ESM returned to stable.
The ESM’s ratings were assigned by evaluating factors that Moody’s considers relevant to the credit profile of the issuer, such as the issuer’s (i) business risk and competitive position compared with others within the industry; (ii) capital structure and financial risk; (iii) projected performance over the near to intermediate term; and (iv) management’s tolerance for risk. Moody’s compared these attributes against other issuers both within and outside ESM’s core industry and believes that the ESM’s ratings are comparable to those of other issuers with similar credit risk.
Moody’s assigns a provisional rating when it is highly likely that the rating will become definitive after all documents have been received. Moody’s will monitor the transaction on an ongoing basis to ensure that it continues to perform in the manner expected. Any subsequent changes in the rating will be publicly announced.