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EFSF, European Stability Mechanism Ratings Cut by Moody’s

December 01, 2012

The European Stability Mechanism and European Financial Stability Facility were downgraded by Moody’s Investors Service, which cited a high correlation in credit risk present among the entities’ largest financial supporters.

The ESM was cut to Aa1 from Aaa, while the EFSF provisional rating was lowered to (P)Aa1 from (P)Aaa. Moody’s said in a statement that it would maintain a negative outlook on each. The EFSF has about 161.8 billion euros ($210.1 billion) of bonds outstanding according to data compiled by Bloomberg.

The move follows downgrades of the EFSF’s second-biggest contributor after France lost its top grade at Moody’s and Standard and Poor’s this year. Investors often ignore such ratings actions, evidenced by the drop in France’s 10-year bond yields since last week’s Moody’s downgrade and a rally in Treasuries after the U.S. lost its AAA at S&P in 2011.

The EFSF’s “rating is at the mercy of the creditworthiness of its biggest backers,” Nicholas Spiro, managing director of Spiro Sovereign Strategy in London, said before the actions. “Another downgrade of the EFSF would show how the creditworthiness of the euro zone’s rescue fund itself is being affected by the worsening economic conditions in the core.”

About half the time, government bond yields move in the opposite direction suggested by new ratings, according to data compiled by Bloomberg in June on 314 upgrades, downgrades and outlook changes going back to 1974.

‘High Correlation’

EFSF debt declined on the fund’s last credit downgrade, when S&P cut the rating by one level to AA+ on Jan 16. The yield premium over benchmark government debt of the EFSF’s 5 billion euros of 2.75 percent senior, unsecured bonds due July 2016 increased 13 basis points on the day of the downgrade to 155 basis points, according to Bloomberg prices. The spread has since narrowed to 55 basis points.

Moody’s statement said that “there is a high correlation in credit risk among the entities’ supporters is consistent with the evolution to date of the euro area debt crisis and the close institutional, economic and financial linkages among the major euro area sovereigns.”

All the debt securities that have been drawn down to date from the EFSF were also downgraded to Aa1 from Aaa, according to the statement released late yesterday.

‘Exceptionally Strong’

The Luxembourg-based EFSF was formed in 2010 to provide loans to cash-strapped European Union countries. The ESM will replace the temporary EFSF, which has spent 192 billion euros of its 440 billion euros on loans to Ireland, Portugal and Greece. The two funds will run in parallel until the EFSF is phased out in mid- 2013.

‘Moody’s rating decision is difficult to understand,’’ Klaus Regling, managing director of the ESM and chief executive officer of the EFSF, said in a statement. “We disagree with the rating agency’s approach, which does not sufficiently acknowledge ESM’s exceptionally strong institutional framework, political commitment and capital structure.”

The 500 billion-euro ESM was set up to aid debt-swamped countries and declared operational on Oct. 8. The fund’s birth was eased by the European Central Bank’s offer in August to buy bonds of fiscally struggling countries, which has driven down interest rates in Spain and Italy and bought European governments time to address the root causes of the crisis.

French Downgrade

Moody’s downgraded France on Nov. 19 said after its Nov. 19 downgrade of France, citing deteriorating growth prospects and declining competitiveness. The rating company then said it would assess the implications of the move for the ratings of the EFSF and ESM.

European Central Bank Executive Board member Benoit Coeure said in a discussion with students in Paris that the downgrade of the EFSF and the ESM itself wasn’t a particular worry.

“If it has the same impact as the French downgrade, it’s not very serious,” Coeure said. “It’s a sort of a warning that has little to do with the ESM and is more about France. It’s an analysis that we might share.”

The short-term issuer rating of the ESM remains unchanged at Prime-1, while the provisional short-term rating of the EFSF were kept at (P)Prime-1.

A provisional rating for a debt facility is an indication of the rating that Moody’s would likely assign to future draw- downs from the facility, pending the receipt of documentation detailing the terms of the debt issuance, the New York-based company said.

To contact the reporter on this story: Craig Stirling in London at

To contact the editor responsible for this story: Dave Liedtka at

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