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The Globe and Mail

S&P downgrades euro zone bailout fund

U.S. rating agency Standard & Poor's cut its credit rating of the European Financial Stability Facility, the euro zone's rescue fund, by one notch to double-A-plus on Monday, three days after it cut the ratings of France and Austria by the same margin.

In a statement, S&P said the decision was all but inevitable following the cuts to the creditworthiness of France and Austria, which were two of the EFSF's guarantors.

"We consider that credit enhancements that would offset what we view as the now-reduced creditworthiness of the EFSF's guarantors and securities backing the EFSF's issues are currently not in place," the agency said in a statement.

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"We have therefore lowered to AA+ the issuer credit rating of the EFSF, as well as the issue ratings on its long-term debt securities.

The EFSF was set up by the 17 governments that share the European single currency in May 2010 and has so far been used to provide emergency loans to Ireland and Portugal. It is also expected to contribute to a second bailout of Greece.

The fund has an effective lending capacity of €440-billion ($557-billion U.S.), which depends on guarantees, mainly from the euro zone's triple-A countries, only four of which now remain: Germany, Luxembourg, Finland and the Netherlands.

In a statement, the EFSF said the downgrade would not affect its lending capacity, and emphasized that its short-term rating remained at S&P's top level.

"The downgrade to 'AA+' by only one credit agency will not reduce EFSF's lending capacity of €440-billion," the fund's chief executive, Klaus Regling, said.

"EFSF has sufficient means to fulfill its commitments under current and potential future adjustment programs until the ESM becomes operational in July, 2012," he added.

The ESM – the European Stability Mechanism – is a permanent rescue fund that is expected to have an effective capacity of €500-billion, based on paid-in capital of €80-billion and callable capital of €620-billion.

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However, details about the structure of the ESM have still not been agreed among all euro zone member states. The original plan was to introduce it in July, 2013, but that was brought forward by a year. Now euro zone policy makers are working hard to ensure the ESM can come into effect in just six months time.

EU leaders will meet for a summit in Brussels on Jan. 30 when they are expected to discuss jobs and growth as well as issues such as the permanent rescue fund and how to go about tackling the threat of a debt default by Greece.

In the long term, and particularly if Moody's and Fitch, the two other major ratings agencies, decide to cut the EFSF's rating as well, it may be impossible for the fund to sustain its effective capacity unless it just accepts that it will issue bonds at a lower credit rating, and pay more to do so.

The alternative would be to ask Germany, Finland, the Netherlands and Luxembourg to increase their total guarantees to the fund to get its credit rating back up to triple-A. It's very unlikely the countries would agree to such a move.

However, S&P said that if the EFSF could find ways of providing credit enhancements, it could reassess its move.

"We understand that EFSF member states may currently be exploring credit-enhancement options," it said.

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"If the EFSF adopts credit enhancements that in our view are sufficient to offset its now-reduced creditworthiness, in particular if we see that once again the EFSF's long-term obligations are fully supported by guarantees from EFSF member-guarantors rated 'AAA' or by securities rated 'AAA', we would likely raise the EFSF's long-term ratings to 'AAA'."

Jean-Claude Juncker, the chairman of the euro group, which represents the 17 euro zone countries, said the implications of S&P's decision would be discussed, probably when finance ministers next meet on Jan. 23.

"We take note and will examine the consequences of the decision announced by Standard & Poor's to downgrade the credit rating," he said in a statement.

"EFSF continues to be assigned the best possible credit rating by Moody's (Aaa) and Fitch (AAA), underlining its solidity. Neither rating agency has indicated any rating action for EFSF in the immediate future."

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