Eurozone bailout fund downgraded by S&P

RATING agency Standard & Poor’s has downgraded the creditworthiness of the eurozone’s bailout fund by one notch to AA+.

It comes as European leaders try to rescue under-fire efforts to deliver new fiscal rules and cut Greece’s debt burden as investors ignore S&P’s eurozone downgrades.

The downgrade, which follows ratings cuts for AAA-rated France and Austria, could hurt the European Financial Stability Facility’s ability to raise cheap bailout money.

While most euro countries guarantee the bonds issued by the EFSF, its rating depends on the AAA countries.

The remaining four do not make up enough guarantees to secure its €440 billion lending capacity.

S&P said it could upgrade the EFSF back to AAA if the eurozone offers new credit enhancements.

S&P had warned in December that it would cut the rating of the EFSF in line with the downgrades of any AAA country.

Moody’s and Fitch, the other big two 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 are likely 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 Holland and Finland.

Another option would be to accept that the EFSF can give out fewer loans.

Because of the EFSF’s set-up the bonds it issues to raise bailout money are underpinned by €720bn 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 €440bn.

With the downgrades of France and Austria, the EFSF loses €180bn in AAA guarantees, leaving it with a loan capacity of €260bn.

Of that, around €40bn has already been committed to the bailouts of Ireland and Portugal, and a new Greek rescue will quickly take more than €100bn out of the till.

While that leaves the eurozone with a severely diminished firewall, the lower lending capacity may not matter that much.

Greek officials will reconvene with creditors tomorrow after discussions stalled last week and other governments are preparing for a January 30 summit as the European Central Bank warns against “watering down” a revamp of budget laws.

French borrowing costs fell yesterday as the government in Paris sold €8.59bn in debt.

The talks on Greece and budgets may serve as tougher tests of the tentative recovery in investor sentiment than S&P’s decision to cut the ratings of nine eurozone nations, including France.

History suggests fallout from the downgrades may be limited.

JPMorgan Chase & Co research shows that 10-year yields for the nine sovereigns that lost their AAA status between 1998 and last year’s US downgrade rose an average of two basis points the next week.

The euro pared declines against the dollar after the ECB was said to buy Italian and Spanish debt, trading at $1.2671.