Rating agency Standard & Poor’s said on Monday it has downgraded the creditworthiness of the eurozone’s rescue fund by one notch to AA+, putting the fund’s ability to raise cheap bailout money at risk.
The downgrade follows ratings cuts for AAA-rated France and Austria, whose financial guarantees were key to the creditworthiness of the European Financial Stability Facility.
If replicated by other rating agencies, S&P’s move complicates the eurozone’s efforts to emerge from a debt crisis that has dragged on for more than two years. It also underlines how reliant states and financial firms still are on the opinion of rating agencies, despite policymakers across Europe vowing on Monday to curtail their influence.
Although the ratings cut had been expected after S&P downgraded nine euro countries on Friday, the EFSF’s top official quickly moved to reassure investors.
“The downgrade to ‘AA+’ by only one credit agency will not reduce (the) EFSF’s lending capacity of 440 billion,” Klaus Regling, the fund’s chief executive officer, said in a statement. He added that the EFSF has enough money to fund the bailouts of Ireland and Portugal, as well as a second rescue for Greece that is likely to be decided in the coming weeks.
S&P had warned in December that it would cut the rating of the 440 billion EFSF in line with the downgrades of any AAA country.
Moody’s and Fitch, the two other big rating agencies, still have the EFSF at AAA, meaning that it would count as a top-notch investment for most funds. But analysts warn that further downgrades could follow soon.
Once another big agency cuts the EFSF’s rating, the eurozone faces a stark choice. Either the fund starts issuing lower-rated bonds and accepts higher borrowing costs or its remaining AAA contributors increase their guarantees.
So far, Germany, the biggest of the four AAA economies in the eurozone, has ruled out boosting its commitments to the fund, and increases also appear politically difficult in the Netherlands and Finland. Luxembourg, the fourth country that S&P still awards its highest rating, is so small that its contributions have little impact.
Another option would be to accept that the EFSF can give out fewer loans.
Because of the EFSF’s strange setup the bonds it issues to raise bailout money are underpinned by some 720 billion in guarantees from the 14 eurozone countries that haven’t received bailouts. But for issuing AAA-rated bonds, only AAA-guarantees count, taking the fund’s lending capacity down to 440 billion.
With the downgrades of France and Austria, the EFSF loses some 180 billion in AAA-guarantees, leaving it with a loan capacity of just over 260 billion. Of that, around 40 billion have already been committed to the bailouts of Ireland and Portugal, and a new Greek rescue will quickly take more than 100 billion out of the till.
While that would leave the eurozone with a severely diminished firewall, the lower lending capacity may not matter that much. To rescue Italy and Spain, the EFSF would need more than 1 trillion, according to analysts, and whether the shortfall is 900 billion or 600 billion won’t make much of a difference.
Mr. Regling said that more support was on the way from the eurozone’s new, permanent rescue fund, the 500 billion European Stability Mechanism, which is expected take over from the EFSF later this year. In contrast to the EFSF, the ESM has paid-in capital, similar to a bank, and is thus less vulnerable to rating downgrades.
Policymakers on Monday nevertheless lashed out against S&P’s downgrades and promised to curtail their influence.
French President Nicolas Sarkozy, in his first public comment since France lost its AAA-rating on Friday, said the move’s importance should not be exaggerated.
“We have to react to this (the French downgrade) with calm, by taking a step back,” he said at a news conference in Madrid. “At the core, my conviction is that it changes nothing.”
Meanwhile, Mario Draghi, president of the European Central Bank, told European lawmakers in Strasbourg, France, that banks and other financial firms should stop basing their risk assessment solely on the opinion of rating agencies.
“One needs to ask how important are these ratings for the marketplace, for the regulators and for investors,” Mr. Draghi said, adding that investors should treat the agencies’ judgments as just one piece of information alongside their own analyses.
The European Union is currently in the process of putting new banking rules into law that cut the reliance on risk assessments from rating agencies. It also has proposed new legislation that would force the agencies to be more transparent about how they reach their decisions and even allow investors to sue firms that misjudged ratings “intentionally or with gross negligence.”