EUROPEAN INVESTMENT FUND

Rating Action 

EthiFinance Ratings confirms its “AAA” rating with a “stable” outlook for the European Investment Fund.

 

Executive Summary 

The European Investment Fund (hereinafter, the EIF and/or the Fund and/or the Entity) is a specialized provider of risk finance for the support of SMEs across Europe. The Entity is an integral part of the European Investment Bank (EIB) Group, the European Union's lending arm. EIF’s shareholders also include the European Union (represented by the European Commission) and an extensive range of public and private banks and financial institutions. 

 

Rating Rationale

Our credit rating is based on the EIF's pivotal role within the European Union structure, supporting the achievement of Public Policy Goals. Notably, we emphasize the exceptional asset quality of the Entity and its effective risk management, characterized by well-defined controls and policies. Additionally, we highlight the EIF's consistent profitability over its history, coupled with a noteworthy level of capitalization and the absence of financial debt. The Fund earns commissions on EIB mandates, EC mandates and regional and funds of funds mandates. Commission income represented 59.8% of the ordinary income in 2022 (2021: 56.6%). 

Our rating’s main pitfalls are related to the EIF’s PE investments in SMEs across very innovative sectors, which are highly risky and illiquid. In fact, the valuation of the PE portfolio has been severely impacted in 2022 due to interest rate hikes. Additionally, the prospects of a weakening economy could be particularly challenging for European SMEs. 

 

Fundamentals 

• Membership in the European Union structure, playing a pivotal role supporting the achievement of Public Policy Goals through the design and deployment of financial instruments.
• Mandate to enhance European small and medium-sized enterprises (SMEs) access to finance by developing and offering targeted financial products to intermediaries, such as banks, guarantee and leasing companies, micro-credit providers and private equity funds
• Explicit support in challenging economic times by the European Union or its member states. During the Covid-19 crisis, the EIF received explicit support in the form of counter-guarantees in order to mitigate the risks related to potential defaults.
• Broad diversification of its activity throughout Europe, showing limited concentration by country, sector or counterparty.
• Significant decline in profitability metrics in 2022 mainly attributable to the loss generated by the change of the fair values of PE investments. The RoA dropped from 13.4% in 2021 to 1.3% in 2022 due to the dramatic drop in valuations driven by interest rate increases, which adversely impacted the value of the PE portfolio. However, we anticipate a reversal in the trend of declining fair values in 2023.
• High asset quality with a low delinquency in the financial guarantee business. The total exposure at risk amounted to €9.5bn in 2022 (2021: €10.9bn) with a 0.1% default rate (0.1%).
• Absence of outstanding debt liabilities and remarkable capitalization. 
• The Fund earns commissions on EIB mandates, EC mandates and regional and funds of funds mandates. Commission income represented 59.8% of the ordinary income in 2022 (2021: 56.6%). 

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Main Ratios

 

Outlook

Our credit rating with stable outlook results from the role the EIF plays in Europe enhancing SMEs access to finance, as well as the support of the shareholders, if needed. 

 

Rating Sensitivities

Factors that individually or collectively could impact the rating: 

•          Factors which could lead to an upgrade

Not applicable.

•          Factors which could lead to a downgrade

The rating could be downgraded if the European Union shifts away its priorities from the EIF, if its own risk investment grows at a higher pace than its capitalization or if the advent of a recession has a material effect on the Fund’s prospects.

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Company Profile

The EIF is a provider of risk finance to small and medium-sized enterprises (SMEs) across Europe. The Fund is part of the EIB Group, the lending arm of the European Union and the biggest multilateral financial institution in the world. Its shareholders are the European Investment Bank, the European Union, represented by the European Commission, and a wide range of public and private banks and financial institutions. 

As at 31 December 2022, total assets amounted to €5.5bn (2021: €5.2bn), total assets under management came to €82.3bn (2021: €71.7bn) and total commitments stood at €9.2bn (2021: €30.5bn).

The EIF was incorporated on June 14th,1994, in Luxembourg, as an international financial institution to contribute to the pursuit of the objectives of the European Union. The Fund pursues this task through two main activities: (i) the provision of guarantees as well as of other comparable instruments for loans and other financial obligations, and (ii) the acquisition, holding, managing and disposal of equity participations of small and medium-sized enterprises within the European Union and the European Free Trade Association (EFTA) countries. In addition, the EIF may engage in other activities connected with or resulting from these tasks.

The AAA / Stable credit rating takes into consideration the financial strength of EIF’s shareholders as well as its role in fostering EU objectives by creating a sustainable financing ecosystem for Europe’s small and medium-sized enterprises. The EIF had an authorized capital of €7,370m, divided into 7,370 shares with a nominal value of €1m each. As of 31 December 2022, 7,300 shares were subscribed and the EIB held 59.4% (4,336 shares), the EU represented by the EC held 30% (2,190 shares) and 38 financial institutions held 10.6% (774 shares). The Fund carries out its activities using either its own resources or those provided by the European Investment Bank, the European Commission, any EU Member States or other third parties.

 

 

In 2022, the EIF has been actively engaged in various initiatives, with a primary focus on supporting the EU's new financing program, InvestEU. Representing approximately 45% of the EIF's activity during the year, InvestEU is designed to enhance European competitiveness and strategic autonomy in key sectors. The EIF has aligned its interventions with thematic priorities, emphasizing public policy objectives such as the transition to a green, digital, and inclusive economy.

In response to the economic challenges posed by the pandemic, the EIF played a crucial role in deploying the European Guarantee Fund through equity and securitization transactions. The organization's efforts have been directed to complement national measures and provide support during difficult times. The EIF has also been instrumental in driving financial recovery of SMEs by facilitating the connection of resources from the EU Member States' Recovery & Resilience Facility allocations into the InvestEU program. 

EthiFinance Ratings values the broad geographic diversification of the EIF, achieving a balanced distribution of recipients both by country and sector. As of 31 December 2022, the EIF’s financial guarantees were spread over 40 countries. The largest weight is Spain with 13.2% (2021: Poland 15.4%), followed by Poland with 12.9% (2021: Spain 11.2%), and France with 10.3% (2021: Italy 11.1%).

The geographic scope of the EIF PE investment activity is mainly focused on Europe, with limited non-European exposure. As of 31 December 2022, France had the largest weight with 12.1% (2021: United Kingdom 12.8%), followed by United Kingdom with 9.8% (2021: France 11.7%) and the United States with 9.9% (2021: United States 9.3%). 

The fund's risk management is remarkable, with high quality standards and a series of well-defined controls. The activity is carried out through mandates, primarily provided by the EIB and the European Commission, as well as other third parties. These mandates come with clear guidelines that serve to constrain any discretionary actions, preventing the entity from deviating from its mission by assuming risks beyond the established parameters.

The statutes of the EIF limit guarantee operations to five times the subscribed capital, as per amendment approved by the Board of Directors. This amounted to €7.3bn at year-end 2022. Hence, the €9.5bn exposure at risk, together with the funded exposure of €402.8m in respect of ABS investments was below the statutory limit of €36.5bn.

During the last year, the EIF underwent governance changes. Since January 1st 2023, the EIF has a new Chief Executive, Marjut Falkstedt, and a new Chair of the Board, EIB Vice-President Gelsomina Vigliotti, marking a historic moment as the organization is led by two women.

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Financial Profile

During 2022, the EIF’s operating profit declined 12.4% to €131.7m (2021: €150.4m) due to a lower ordinary income. 

Net income from PE investments declined by €12.4m due to a lower dividend income. Net result on financial operations declined by €13.1m due to a realised loss on debt investments at amortised cost and lower gains arising from transactions or cash positions in foreign currencies compared to the previous year. Net result from financial guarantee operations declined by €4.4m due to lower fees received for the guarantees. Lastly, commission income declined by €4.6m due to lower commissions on EIB mandates, partially cancelled by higher commissions on EC mandates and higher commissions on regional and funds of funds mandates. Nevertheless, interest and similar income increased by €7.2m due to a higher interest income on debt investments and money-market instruments, as well as a lower interest expense on bank current accounts.

The EIF’s ordinary income consisted mainly of commission income, which contributed 59.8% of the total (56.6%), followed by net result from financial guarantee operations, with 20.6% (20.3%), net income from private equity investments, with 14.3% (16.6%), and interest and similar income with 5.3% (2.9%).

Commission income totaled €203,2m in 2022 (2021: €207.7), comprising commissions on EIB mandates, which represented 26.1% (31.3%), followed by commissions on EC mandates, with 27.4% (25.1%), and commissions on regional and funds of funds mandates 46.5% (43.4%). Net result from financial guarantee operations amounted to €70.0m (€74.5m), mainly including guarantees for certain tranches of notes (senior and/or mezzanine tranches) issued through SME securitization transactions.

EIF’s general administrative expenses YOY slightly decreased to €207.8m (2021: €216.3m) due to lower social security and contribution costs. The number of persons employed at the year-end amounted to 630 (599).

Moreover, EIF’s profit generated by the change of the fair values decreased sharply from €413.9m in 2021 to €-61.3m in 2022, which was mainly driven by the net result from financial instruments at fair value through profit or loss of private equity investments, and, to a lesser extent by the instruments at FV of financial guarantees and debt investments.

Net result from financial instruments at FV through profit or loss of PE investments came to €-39.9m, declining by around €454m compared to the previous year. This dramatic drop is explained by the sharp decline in valuations caused by the strong increase in interest rates during 2022 aimed at holding back inflation, which had an adverse impact on the PE portfolio’s performance. The European Central Bank (ECB) raised rates from 0% in July to 2.5% in December and continued during 2023, reaching 4.5% in September. For instance, the LPX Europe PE Index experienced a 36% decline in 2022. 

In 2022, the EIF saw an 87.5% decline in net profit, amounting to €70.4m (2021: €564.4m). This drop was mainly due to the loss generated by the change of the fair values, primarily of private equity investments. 

The EIF’s profitability has decreased substantially in 2022 compared to the previous year. The RoA dropped from 13.4% in 2021 to 1.3% in 2022. Similarly, the RoE went down to 1.7% in 2022 from 19.0% a year before. 

The EIF had a remarkable performance for the financial year 2021 compared to previous years. Ordinary income benefitted from a sharp rise in net income from PE investments, a higher commission income and a positive net result on financial operations. Net profit was also positively impacted by the net result from financial instruments at FV through profit or loss of PE investments as valuations saw a strong increase during 2021.

 

 

The EIF’s assets totaled €5.5bn in 2022 (2021: €5.2bn). The treasury portfolio, which increased twofold in 2021 to €2.4bn, remained at a similar level in 2022, accounting for 44.4% of total assets (47.2%). The treasury portfolio comprises long-term bank deposits and a long-term portfolio spread over 37 countries, including bonds issued by EU sovereigns and non-EU sovereigns, as well as corporate bonds. The highest individual country exposures were France, Spain, United States, Germany, and United Kingdom, which jointly represented 48% of total nominal value. 

In nominal terms, 74.2% of all assets held have a duration of 5 years or less (2021: 64.4%). More than 70% of the securities had a credit rating equal to or higher than A-. The average yield at cost on the securities portfolio in euros was 0.36% for 2022 (0.23%). The risk of these investments is reduced by limiting investments to those assets with an investment grade rating, high liquidity and limited counterparty concentration.

Private equity investments at fair value through profit or loss represented 28.7% of total assets in 2022 (2021: 29.7%), amounting to €1.6bn, similar to the previous year. PE Funds are generally structured as Limited Partnerships, where the Limited Partners, such as the EIF, commit a certain amount of capital to be called at the discretion of the fund manager, which is acting as General Partner.

As of 31 December 2022, the PE portfolio had a balanced exposure to different investment strategies, including venture capital investments ranging between the early and late stage (29.3%); private equity targeting equity and mezzanine investments in SMEs (24.2%), private debt (23.4%) and infrastructure investments covering equity capital toward tangible, physical assets, whether existing or development phase (21.4%), with a smaller exposure to generalist investments via fund-of-funds vehicles (1.7%).

The specific characteristics of the PE asset class make it difficult to apply traditional approaches to equity risk analysis. Therefore, the EIF uses a beta derived from the betas of three listed PE indices to estimate the sensitivity of the valuation of the EIF’s PE investments to market prices. Regression has been carried out using the Dow Jones Euro Stoxx 50 over the last three years.

The PE portfolio had performed remarkably well in the past with a low interest rate environment. However, the dramatic drop in valuations brought about by interest rate hikes in 2022 adversely impacted the portfolio’s performance. During 2023, the value of the PE investments should have recovered some of their value in line with PE indices. For instance, the LPX Europe PE Index saw a 22% increase. Using the beta derived from the betas of the three listed PE indices of 1,05 and the increase of the Dow Jones Euro Stoxx 50 of 16% during the year, the PE portfolio’s value would have risen by approximately €273m, recovering 17% of its value in 2023.

Risk management is an integral part of the management of the EIF’s investment activities. The EIF has developed a set of tools to design, monitor and manage the portfolio of PE funds. This set of tools is based on an internal process and model, the Grading-based Economic Model. 

The PE portfolio is well diversified across a large number of funds and geographies. The largest fund in the portfolio represented 1.6% of the portfolio fair value in 2022 (2021: 1.4%) and the largest 10 funds represented in aggregate 10.8% (11.6%). Moreover, the largest geographical exposure accounted for 12.1% of the EIF’s portfolio, even though the geographic scope is principally focused on Europe. PE investments are also well diversified in terms of sector and activity.

The performance of the EIF’s guarantee transactions has been remarkable over the last few years, showing very low levels of defaulted transactions. As of 31 December 2022, the total exposure at risk amounted to €9.5bn (2021: €10.9bn) with a 0.1% default rate (0.1%). Nevertheless, the transactions classified as “under review” have increased from 6.4% in 2021 to 7.8% in 2022, reflecting prospects of a weakening economy owing to inflationary pressures and higher interest rates, which could be particularly challenging for European SMEs. 

The credit risk is managed by risk management policies covered by the statutes and the EIF Credit Risk Policy Guidelines. The statutes of the EIF limit guarantee operations to five times the subscribed capital, as per amendment approved by the Board of Directors. This amounted to €7.3bn at year-end 2022. Hence, the €9.5bn exposure at risk, together with the funded exposure of €402.8m in respect of ABS investments was below the statutory limit of €36.5bn. Moreover, only 0.5% of the financial guarantees had a rating below investment grade. Additionally, the concentration in terms of geography, sector and counterparty remained very low.

 

 

The AAA / Stable credit rating takes into account the Fund’s absence of debt. Liabilities accounted for 20.5% of the EIF’s total assets in 2022 (2021: 23.4%). They comprised financial liabilities at amortized cost (2.9%), retirement benefit obligations (7.1%) and other liabilities and provisions (10.5%), including related parties payables, employee benefit payables, trade creditors and provision for risks and liabilities. 

In 2022, the EIB provided a funding line under the InvestEU Programme amounting to €157.9m, which was mainly used to finance guaranteed funded operations totaling €72.8m. This additional funding through an intra-group loan to support the implementation of the new InvestEU programme is considered as operational debt rather than financial debt. The EIF's exposure under the InvestEU program is balanced by the intra-group loan, ensuring that the repayment of both interest and principal is fully secured by cash inflows from the existing portfolio and backed by a guarantee from the EU. 

The equity represented 79.5% of the Fund’s total assets at year-end 2022 (2021: 76.6%). The authorized capital amounted to €7.4bn, of which €70m were not yet subscribed. The EIF is required to add to a statutory reserve at least 20% of its annual net profit until the reserve amounts to 10% of subscribed capital. A minimum amount of €14.1m is required to be added in 2023 with respect to the financial year 2022. A dividend of €15.0m was distributed (2021: no dividend). Regarding the EIF’s on balance-sheet investments, the equity covered 97.3% of the exposure in 2022 (90.9%). Adding the financial guarantees’ exposure at risk to the Fund’s total assets, the equity accounted for 29.2% (24.7%).

EthiFinance Rating’s values the EIF’s robust liquidity resulting from highly liquid investments, complemented by potential shareholder support. The Fund's cash position and investments in fixed income instruments are deemed highly liquid due to their high credit quality and the dynamic nature of the securities market. In 2022, these components collectively constituted around 60% of total assets, significantly surpassing liabilities.

 

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Environmental, Social & Governance

The European Investment Fund demonstrates a strong commitment to Environmental, Social, and Governance (ESG) principles across its operations. As a financial institution, the EIF's activities impact a broad spectrum of industries and sectors. By aligning its interventions with public policy objectives and promoting sustainable investments, the EIF is positioned as a key player in advancing the broader ESG agenda. 

Governance is a fundamental aspect of the EIF's ESG framework, and the organization has undergone significant internal changes in this regard. The appointment of a new Chief Executive and Chair of the Board, both women, signals a positive shift toward gender diversity in leadership. 

The EIF has two main bodies: the Board of Directors and the General Assembly. The Board of Directors is composed of a majority of EIB and EU members, with the participation of other shareholders. The General Assembly is composed of one representative of the EIB, one member of the European Commission representing the EU and one member corresponding to each financial institution. Decisions of the EIF are taken by simple majority, but major decisions concerning the fund's capital or the scope of activities it may undertake are taken by qualified majorities.

The AAA / Stable credit rating incorporates the positive assessment of the internal policies, controls and procedures of the Fund. Risk management is carried out through a three-line of defense model: the first line refers to the front office, the second line refers to compliance and independent risk management, and the third line refers to internal and external audit. Additionally, the EIF has an Internal Control Framework (ICF) as part of the second line of defense, which issues an annual report that is complemented with an independent opinion.

In terms of environmental responsibility, the EIF plays a pivotal role in promoting sustainability through its financing activities. The launch of InvestEU in 2022, with a dedicated guarantee instrument exclusively for sustainability, underscores the EIF's emphasis on environmentally conscious investments. 

On the social front, the EIF actively contributes to inclusion and cohesion, particularly in less developed regions. With 39% of financing benefiting entities in cohesion regions of the EU, the EIF plays a crucial role in reducing regional disparities. Furthermore, the organization focuses on social impact, human capital, and inclusive finance, aiming to address inequalities at the micro level. 

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Scorecard

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Financial Statements