This time, it raise a caution flag for the EFSF:
The ‘AAA’ rating on debt issues of the European Financial Stability Facility (EFSF) largely depends on France and Germany retaining their ‘AAA’ status. The revision of the rating Outlook on France to Negative last Friday implies that the risk of a downgrade of EFSF debt has increased.
We affirmed France’s ‘AAA’ status but warned that that there is a slightly greater than 50% chance of a downgrade within the next year or two. This is therefore also the case for the ‘AAA’ ratings assigned to the EFSF’s debt issues, unless additional credit enhancement mechanisms are introduced.
The ‘AAA’ ratings assigned to EFSF debt issues rely on the EUR726bn of irrevocable and unconditional guarantees provided by the euro member states, and on the conservative guidelines the EFSF sets itself regarding debt management and liquidity risk.
Of the guarantees and over-guarantees from ‘AAA’ rated member states, France and Germany provide EUR369.6bn, or over 80%. Although the EFSF could potentially remedy a downgrade of a small ‘AAA’ guarantor by increasing the size of its cash reserve or through additional credit enhancements, this would be far more challenging if a larger guarantor like France or Germany were downgraded. The primary source of ratings risk for EFSF debt issues is therefore the possibility that one or more of its largest ‘AAA’ guarantors is downgraded.
Because we do not assign Outlooks to the ratings of individual debt issues, but rather to our issuer ratings, the change in the French issuer rating Outlook cannot immediately be reflected in changes to our assessment of EFSF debt issues. We rate EFSF debt issues but not the EFSF itself, as it is the former rather than the latter that benefit from sovereign guarantees.
Under the amended Framework Agreement announced at the EU summit on 21 July, ‘AAA’ rated euro member states provide EUR451.5bn of guarantees and over-guarantees, giving the EFSF a maximum lending capacity of EUR440bn.
France is the most exposed of the ‘AAA’ euro member states to a further intensification of the eurozone sovereign debt crisis. It provides EUR158.5bn of guarantees plus over-guarantees to the EFSF guarantee pool under the framework agreement.
When we revised France’s rating Outlook, we noted that an increased likelihood that contingent liabilities arising from the crisis will be crystallised onto France’s balance sheet, material slippage from fiscal targets, and a re-assessment of France’s economic growth potential, could each trigger a rating downgrade. Conversely, economic and fiscal performance in line with our base case expectations, along with a resolution of the eurozone debt crisis, would be likely to result in a revision of the Outlook to Stable.