Frankfurt am Main, June 10, 2022 -- Moody's Investors Service ("Moody's") has today upgraded the European Stability Mechanism's (ESM) long-term issuer and senior unsecured ratings to Aaa from Aa1, the senior unsecured MTN programme rating to (P)Aaa from (P)Aa1, and affirmed the short-term issuer rating at P-1 as well as the other short-term ratings at (P)P-1/P-1.
At the same time, Moody's has upgraded the European Financial Stability Facility's (EFSF) long-term issuer and backed senior unsecured ratings to Aaa from Aa1, the backed senior unsecured MTN programme rating to (P)Aaa from (P)Aa1, and affirmed the EFSF's backed other short-term rating at (P)P-1.
The outlook remains stable for both the ESM and the EFSF.
The key driver for today's rating actions is Moody's view that the improved robustness of the European crisis-fighting architecture – as exemplified during the coronavirus pandemic – reduces the risk of a systemic crisis with a high default correlation among EU member countries. During the pandemic, the substantial crisis support funded by joint debt issuance under the auspices of the European Union (EU, Aaa stable), together with continued supporting measures from the European Central Bank (ECB), have strengthened the confidence in the resilience of the EU and its member states and by extension also of the euro area and its member states.
As a consequence, in the highly unlikely event of the Government of France (Aa2 stable) as the second largest supporter to ESM and EFSF defaulting, Moody's views it now as less likely than previously assumed that most lower rated euro area member states would be in default, too. While the ratings of the largest and highest-rated shareholders – in particular the Government of Germany (Aaa stable), France and the Government of the Netherlands (Aaa stable) – remain of high importance for the ESM's and EFSF's ratings, the reliance on any single member state rating, in particular on France's rating, has in Moody's view declined.
Please see the individual issuer-specific statements below for the detailed rating rationales.
MOODY'S UPGRADES THE ESM'S RATINGS TO Aaa, OUTLOOK STABLE
Moody's has today upgraded the ESM's long-term issuer and senior unsecured ratings to Aaa, the senior unsecured MTN programme rating to (P)Aaa, and affirmed the short-term issuer rating at P-1 and the other short-term ratings at (P)P-1/P-1. The outlook remains stable.
Key drivers for the ratings upgrade are:
(1) The increased robustness of European crisis-fighting architecture, that includes the EU and the ECB, which in Moody's view reduces the risk of a systemic crisis with a high default correlation among EU member countries. The dependence of the ESM's rating on a single shareholder's rating – namely France – has declined in Moody's view;
(2) The expected benefits to ESM's credit profile resulting from ESM Treaty reform, which will prospectively reduce concentration risk by lowering the shareholder-borrower overlap in the event of a crisis, weakening the ESM's exposure to a potential systemic crisis.
The stable outlook is supported by the very high shareholder support, including sizable callable capital and Moody's view of very strong extraordinary support, if needed. Furthermore, the ESM's credit profile is underpinned by the ESM's very strong credit metrics, marked by low leverage, very strong asset performance, and extremely strong liquidity and very high quality of funding.
RATINGS RATIONALE
RATIONALE FOR THE UPGRADE TO Aaa
FIRST DRIVER: IMPROVED ROBUSTNESS OF EUROPE'S CRISIS-FIGHTING ARCHITECTURE
The coronavirus pandemic tested the European architecture of crisis-fighting mechanisms. Moody´s recognizes that core European institutions like the EU and the ECB are able and determined to act in times of crisis. The expansion of the EU´s crisis-fighting instruments – in particular the implementation of the Next Generation EU programme which is, in addition to loans, based on grants – reduces to some degree the mutuality and interdependence of risk stemming from euro area membership.
The expanded European crisis-fighting architecture reduces the ESM´s default dependence on any single member country, including France, the ESM´s second largest shareholder given the reduced likelihood of a systemic crisis with very high default correlation.
SECOND DRIVER: PROSPECTIVE BENEFITS FROM ESM TREATY REFORM
Moody's expects that certain elements of the pending ESM Treaty reform will potentially reduce ESM´s borrower concentration as well as the borrower-shareholder overlap, and can lower the exposure of the ESM to a systemic crisis.
One key element of the reform is that the ESM will become the common backstop for the Single Resolution Fund (SRF), the instrument of the Single Resolution Mechanism (SRM) which finances the resolution of failing credit institutions within the EU's banking union in cases the private sector cannot agree on recovery plans. This will reduce concentration risk by lowering the shareholder-borrower overlap in the event of a crisis, lowering the exposure of the ESM to a systemic crisis.
The expected introduction of changes to existing lending programs will incentivize member states to seek financial support before facing financial distress, which will further reduce contagion risks. Moody's also notes ESM's prospective stronger role in preparing and monitoring future financial assistance programs.
Moody's expects that the delay to the ESM Treaty reform because of the stalled legislative process in Germany and the Government of Italy (Baa3 stable), which has pushed back the implementation from January 2022, will prove to be temporary.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook reflects Moody's view that downside risks to the Aaa rating are effectively mitigated by the entity's very strong credit profile. The stable outlook is further supported by the very high shareholder support and the ESM's strategic role as a key crisis-fighting European institution.
The ESM has substantial paid-in capital of €80.5 billion or 11.4% of the total subscribed capital of €704.8 billion at end-2021. The ESM has retained all net profits generated since its creation which has increased its reserve fund and further strengthened its capital position. This results in a comparatively low leverage ratio of 115.6%, one of the lowest among Moody's-rated multilateral development banks (MDBs). Moody's is unaware of any registered loan delinquency to date and expects that ESM's asset performance will remain solid in the coming years.
The ESM's liquidity position and funding structure are very strong. The institution runs a very prudent liquidity and capital management policies intended to ensure that there is no shortfall of available liquid assets to service its obligations under various stress assumptions.
Finally, the ESM's financial strength is further supported by a robust oversight and the ESM management's capabilities of proactively managing potential credit pressures – namely the risk of non-payment of one of its three borrowers – through its Early Warning System (EWS) with a significant lead time. The ESM also participates in missions to programme countries and closely cooperates with the European Commission, the ECB and the IMF.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
The ESM's credit impact score is positive (CIS-1), driven mainly by its very strong governance framework coupled with neutral-to-low exposure to environmental and social risks. Furthermore, given its role as the euro area's permanent crisis-resolution mechanism the ESM benefits from very strong support by its euro area sovereign shareholders.
The ESM's environmental issuer profile score is neutral-to-low (E-2) because its issuer profile shows limited exposure to environmental risks. The ESM's environmental risk exposure stems from its three sovereign borrowers (Greece, Spain, Cyprus), which have either neutral-to-low or moderately negative exposure to environmental risks. The ESM's comprehensive risk management framework helps to mitigate and manage any risks that could potentially arise from borrowing countries facing exposure to physical climate or other environmental risks.
The ESM's social issuer profile score is neutral-to-low (S-2). Given its role as the euro area's permanent crisis-resolution mechanism, social considerations such as customer relations, responsible production or demographic and societal trends are not relevant to the ESM's credit profile.
The ESM's governance issuer profile score is positive (G-1). The governance profile shows particular strengths in risk management and overall quality of management. A key feature is the ESM's Early Warning System which enables the ESM to rapidly call on additional capital from shareholders should there be a rising risk of non-payment from one of its borrowers. The ESM participates in missions to programme countries and closely cooperates with the European Commission, ECB and IMF.
The specific economic indicators, as required by EU regulation, are not available for this entity.
On 07 June 2022, a rating committee was called to discuss the rating of the European Stability Mechanism (ESM). The main points raised during the discussion were: The issuer's governance and/or management, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The systemic risk in which the issuer operates has decreased.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
WHAT COULD CHANGE THE RATINGS UP
The ESM's rating is Aaa, which is already at the top of Moody's rating scale. An upgrade to a higher rating is therefore not possible.
WHAT COULD CHANGE THE RATINGS DOWN
Indication of waning shareholder support towards the ESM would be credit negative. While the ESM's credit profile is resilient to weakening creditworthiness of individual member states, the ratings would face downward pressure in a systemic crisis that would weigh on shareholders' ability to provide support. In particular, the ESM's rating would be sensitive to simultaneous rating downgrades of large and highly-rated shareholders.
MOODY'S UPGRADES THE EFSF TO Aaa, OUTLOOK STABLE
Moody's has today upgraded the EFSF's long-term issuer and backed senior unsecured ratings to Aaa, and the backed senior unsecured MTN programme rating to (P)Aaa. The EFSF's backed other short-term rating was affirmed at (P)P-1. The outlook remains stable.
RATINGS RATIONALE
RATIONALE FOR THE UPGRADE TO Aaa
In line with the rating upgrade for the ESM, Moody's sees the increasing robustness of the European crisis-fighting architecture as a key driver for the decision to upgrade the EFSF's ratings. In addition, Moody's regards the reputational damage to the ESM and its shareholders as very high were the EFSF to default, which supports the alignment of the two entities' ratings.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook reflects the very high strength of member support, which in turn is based on the strong ability of the EFSF's guarantors to provide financial support if needed, and their very high willingness to support, as embedded in the very strong guarantee mechanism and Moody's assumption of very strong extraordinary support in case needed. Moreover, the institution's prudent liquidity management and very solid market access mitigates refinancing risks.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Environmental risks are not material for the EFSF's rating. Environmental risk exposure stems from its three sovereign borrowers (Ireland, Greece, Portugal), which have either neutral-to-low or moderately negative exposure to environmental risks. The EFSF's comprehensive risk management framework (through the ESM) helps to mitigate and manage any risks that could potentially arise from borrowing countries facing exposure to physical climate or other environmental risks.
Social risks are not material for the EFSF's rating, amid the relative social and political stability within the euro area. While all euro area member states face long-term challenges related to demographic and other social developments, social considerations do not directly influence the EFSF's rating in a material way.
Governance considerations are material. The sound governance framework is illustrated by prudent risk management policies, and high standard governance principles, aligned with the ESM which carries out all day-to-day business for the EFSF.
The specific economic indicators, as required by EU regulation, are not available for this entity.
On 07 June 2022, a rating committee was called to discuss the rating of the EFSF (European Financial Stability Facility). The main points raised during the discussion were: The issuer's governance and/or management, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The systemic risk in which the issuer operates has decreased.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
WHAT COULD CHANGE THE RATINGS UP
The EFSF's rating is Aaa, which is already at the top of Moody's rating scale. An upgrade to a higher rating is therefore not possible.
WHAT COULD CHANGE THE RATINGS DOWN
Signs of weakening shareholder support towards the EFSF would be credit negative. While the EFSF's credit profile is resilient to deteriorating creditworthiness of individual guarantors, the rating would likely face downward pressure in a systemic crisis that would lead to a significant reduction in guarantors' ability to honour their guarantees. The EFSF's rating would be particularly sensitive to simultaneous rating downgrades of large and highly-rated shareholders.
The principal methodology used in these ratings was Multilateral Development Banks and Other Supranational Entities Methodology published in October 2020 and available at https://ratings.moodys.com/api/rmc-documents/69182. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
REGULATORY DISCLOSURES
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the issuer/deal page for the respective issuer on https://ratings.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
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These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website https://ratings.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on https://ratings.moodys.com.
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Steffen Dyck
Senior Vice President
Sovereign Risk Group
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Alejandro Olivo
MD-Sovereign/Sub Sovereign
Sovereign Risk Group
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Releasing Office:
Moody's Deutschland GmbH
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JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
