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Fitch Affirms European Stability Mechanism at 'AAA'; Outlook Stable
March 7, 2014 / 5:08 AM / 4 years ago

Fitch Affirms European Stability Mechanism at 'AAA'; Outlook Stable

PARIS/LONDON, March 07 (Fitch) Fitch Ratings has affirmed the European Stability Mechanism's (ESM) Long-term Issuer Default Rating (IDR) at 'AAA' with a Stable Outlook and Short-term IDR at 'F1+'. KEY RATING DRIVERS The affirmation and Stable Outlook reflect the following key rating factors: ESM's ratings are underpinned by the strong level of support provided by the 17 euro area member states (EAMS), reflected in the large amount of callable capital subscribed (EUR620bn) and the high share (61.6%) of callable capital provided by shareholders rated 'AA-' and above. If ESM operates at full capacity, 92.3% of its debt would be covered by liquid assets and the callable capital of EAMS currently rated at least 'AA-'. However, the overall credit quality of EAMS has declined since ESM inception. Over time, this could result in a weakening in the quality of support. ESM's callable capital mechanism is stronger than that of other multilateral development banks (MDBs). Capital can be called not only to replenish capital in the event of losses, but also to increase ESM's lending capacity. To avoid a default from ESM on its debt obligations, an emergency capital call procedure, unique among MDBs, has been established. It allows the ESM's managing director to call capital without approval of the governing bodies. The commitment of EAMS to provide callable capital is legally binding. ESM benefits from a relatively high capitalisation ratio and the requirement that paid-in capital/reserves will always be equal to at least 15% of outstanding debt. In the event that the ESM reached its EUR500bn lending capacity limit, the equity-to-assets ratio would stand at 13.8%, which is in line with other 'AAA' rated European MDBs. As of end-December 2013, EUR64bn out of the total subscribed capital of EUR80bn had been paid in, with the balance to be disbursed by April 2014. Risk management guidelines are conservative, especially for liquidity. They ensure that ESM will not suffer a cash shortfall in the event of a default from a borrower. Funds from the paid-in capital will not be lent and will be used as a liquidity buffer, which is expected to cover ESM's liquidity needs for the next 12 months. Investments in liquid assets are governed by conservative rules. As of end-December 2013, the minimum rating requirement for treasury assets is 'AA'. ESM enjoys preferred creditor status (PCS) only junior to the IMF, which reduces sovereign credit risk and enhances recovery prospects in the event of default. PCS is clearly stated in the founding treaty of ESM, which is unique among MDBs. However, the PCS does not apply to the EUR41.3bn facility granted by the European Financial Stability Facility (EFSF; AA+) to the Spanish government that was transferred to and replaced by the ESM financial assistance. It does apply to the EUR9bn financial assistance facility provided to Cyprus, on which EUR4.6bn had been drawn as of end-December 2013. These features offset the extremely high concentration of assets, which constitutes ESM's main weakness. As of end-December 2013, lending was concentrated on only two sovereign borrowers, Spain and Cyprus. ESM has no concentration limit and all its financing could, in an extreme scenario, be concentrated on a single borrower. Member states agreed in 2013 to extend ESM's mandate to Direct Recapitalisation Instruments (DRI), aimed at financial institutions in the eurozone. DRI will become operational once the Single Supervisor Mechanism has been approved, ie not before November 2014. In Fitch's view, capital injections into banks, which are inherently riskier than loans and not protected by PCS, will likely weaken ESM's intrinsic credit quality, making its IDR reliant on support from EAMS. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that downside risks to the 'AAA' rating are currently not material. As DRI is implemented, the ability and willingness by EAMS to support the ESM will become more important to its rating than its intrinsic strengths. Fitch considers support as currently commensurate with ESM's 'AAA' rating thanks to the specificity of the callable capital mechanism and the still high average rating of EAMS despite past ratingrevious downgrades. However, further downgrades, particularly of a large highly-rated EAMS, would exert downward pressure on ESM's IDR. Fitch could adjust these rating sensitivities if the implementation of DRI was accompanied by significant credit risk mitigants that supported the intrinsic strengths of the ESM, thereby making the rating less dependent on support from EAMS. KEY ASSUMPTIONS The ratings and Outlook are sensitive to a number of assumptions: - The ratings are based upon the assumption of ESM using its full lending capacity under the existing legislative framework. - Fitch assumes that the risk of fragmentation of the eurozone remains low. - Fitch assumes that no large EAMS will choose to leave the eurozone and that highly rated member states will remain committed to responding to any capital call. - With the exception of the introduction of DRI, Fitch expects no significant change in the overall mandate and operations of the ESM. Contact: Primary Analyst Eric Paget-Blanc Senior Director +33 1 44 29 91 33 Fitch France S.A.S. 60 rue de Monceau 75008 Paris Secondary Analyst Amelie Roux Director +33 1 44 29 92 82 Committee Chairperson Tony Stringer Managing Director +44 20 3530 1219 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:; Hannah Huntly, London, Tel: +44 20 3530 1153, Email: Additional information is available at Applicable criteria, 'Rating Multilateral Development Banks', dated 23 May 2012, are available at Applicable Criteria andALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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