PARIS (MNI) – Moody’s Investors Service Monday assigned an AAA
credit rating to Europe’s new bailout fund, the European Stability
Mechanism, which held its inaugural meeting today in Luxembourg.

The text of Moody’s statement on the ESM rating follows:

“Moody’s Investors Service has today assigned a long-term issuer
rating of Aaa and a short-term issuer rating of Prime-1 to the European
Stability Mechanism (ESM). The outlook is negative.

The Aaa/Prime-1 ratings are based on (i) the ESM’s anticipated low
leverage, (ii) the creditworthiness of the ESM’s members which are also
the euro area member states, (iii) the sound liquidity and capital
management policy with an Early Warning System (EWS) which ensures that
funds will be available on time, and (iv) 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.

RATINGS RATIONALE

The first key rating factor underlying Moody’s decision to assign a
Aaa rating to the ESM 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.
In such a scenario, loans under existing programmes would continue to be
disbursed, but any new lending commitments, which would surpass the
lending capacity, would require a simultaneous increase in the ESM’s
capital.

The second key rating factor underpinning the Aaa/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 Aaa, with
the two main member states in terms of their capital contribution,
Germany and France, both holding Aaa ratings.

The third key rating factor is the ESM’s strong liquidity and
capital management policy. In particular, the policy aims to ensure that
all payments over the next 12 months are fully covered by the ESM’s own
liquidity reserves and callable capital to be contributed by Aaa-rated
shareholders. An additional 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 Aaa-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 Aaa rating reflects the negative
outlooks on all but one of its Aaa-rated member states and guarantors.
The Aaa-rated member countries that currently have a negative outlook
include some that have significant contribution keys, such as Germany
(which holds a 27.1% share in the subscribed capital), France (20.4%)
and the Netherlands (5.7%). The only Aaa-rated ESM member that has a
stable rating outlook is Finland, whose contribution key is 1.8%.

WHAT COULD MOVE THE RATING DOWN

Although the ESM compares favourably to other Aaa-rated
Multilateral Development Banks (MDBs) in terms of members
creditworthiness, there are several key differences in how the ESM’s own
creditworthiness could be weakened:

1.) A deterioration in the creditworthiness of the euro area member
states (as reflected by a change in Moody’s ratings for these states)
would weigh on the combined ability to provide support, and consequently
have a negative effect on the creditworthiness of the ESM. In light of
the correlation of euro area member states’ creditworthiness, the ESM is
more susceptible to movements in the creditworthiness of its individual
members than are many other MDBs, as reflected by the sensitivity of the
ESM’s rating to changes in the ratings of Aaa countries with large ESM
contribution keys, i.e. Germany, France and the Netherlands.

2.) A weakening in the political commitment among euro area member
states to the ESM could have negative rating implications. The ESM’s
policy mandate is related to the preservation of the euro area and is
therefore more narrowly defined compared to other MDBs. This could
potentially affect the willingness to offer support in a scenario that
includes a euro area break-up, although this is not currently Moody’s
central assumption.

3.) The ESM’s asset side points to significant correlation risks,
which weaken the intrinsic strength of the ESM and make it potentially
more dependent on members’ support. By comparison, MDBs usually have a
relatively diversified asset structure.

4.) Although the ESM ensures that all payments due over the next 12
months are fully covered by its own liquidity reserves and by callable
capital to be contributed by Aaa-rated shareholders, the inclusion of
callable capital in the calculation separates the ESM from other MDBs,
which often have one year of coverage based only on their own liquidity
reserves. This reinforces the correlation of the ESM’s rating with the
rating of its largest Aaa contributors.

5.) Since the ESM’s Aaa rating is based on the assumption of
superior financial-management capabilities, transition/downgrade risks
could also arise from a potential erosion of those capabilities. An
inappropriate skill transfer or skill acquisition would therefore
adversely affect the ESM’s governance and risk management practice.

Conversely, Moody’s would consider moving the outlook for the ESM’s
ratings to stable if the rating agency decided to change to stable the
outlooks on the ratings of those Aaa member states with key
contributions to the ESM’s capital.

METHODOLOGY

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 ESM’s ratings are comparable to those of other issuers with
similar credit risk.”

–Paris newsroom, +331-42-71-55-40; paris@mni-news.com

[TOPICS: M$X$$$,MGX$$$,M$$CR$,MT$$$$]