Fitch affirms European Union, Euratom at 'AAA'; outlook stable

Fitch Ratings has affirmed the European Union's (EU) and the European Atomic Energy Community's (Euratom) Long-term Issuer Default Ratings (IDRs) at 'AAA' and their Short-term IDRs at 'F1+'. The Outlooks on the Long-term IDRs are Stable. The issue ratings on the EU's and Euratom's senior unsecured bonds are also affirmed at 'AAA'.

KEY RATING DRIVERS

As supranational administrative bodies, the Euratom's and EU's IDRs are dependent on support provided by their member states (MS). More specifically, they reflect Fitch's view that the Euratom's and EU's debt is ultimately backed by EU budget revenues, which depend on MS's ability and propensity to honour their budget commitments to the EU.

The EU's indebtedness (EUR57bn at end-2014) is only incurred for the purpose of on-lending to MS (through the balance of payment and the European Financial Stabilisation Mechanism programmes - BoP and EFSM) or to neighbouring sovereigns (through the Macro-Financial Assistance programme - MFA). The EU is not allowed to borrow for other purposes than on-lending to sovereigns. Euratom's indebtedness (EUR0.3bn at end-2014) is dedicated to on-lending to MS or neighbouring countries to finance nuclear power projects.

Credit risk is significant, as the EU only lends to sovereigns facing economic difficulties. The loan book is also concentrated, with 82.1% of EU loans extended to Ireland (A-/Stable) and Portugal (BB+/Positive) at end-2014 through the EFSM, but the quality of these exposures has recently improved with the upgrade of Ireland and Positive Outlook on Portugal. This credit risk is also partly mitigated by our expectation that the EU and Euratom would benefit from preferred creditor status compared with private creditors in a restructuring scenario. Neither of the two issuers has ever suffered a default on their loan portfolios.

Market risks are marginal, as loan and bond features and maturities are aligned. Fitch expects this back-to-back structure would be respected even should the EU refinance some of its bonds in the likely case of Ireland and Portugal extending the maturity of some of their EFSM loans from 2015, as made possible by a revised EU legislation.

The EU's and Euratom's creditworthiness is supported by EU legislation, which allows their debt to be repaid through priority recourse to EU budget revenues over other non-priority expenses. Under the Multiannual Financial Framework (MFF) defining budget orientations for 2014-2020, yearly resources transferred by MS to the EU will amount to an average 0.99% of EU gross national income (GNI) over 2014-2020, representing over EUR135bn per year in current prices, compared with a maximum yearly debt service of the EU and Euratom of EUR9.4bn over this period.

Availability of such resources depends on MS's ability and willingness to contribute to the EU budget, which Fitch expects to remain strong. Despite numerous downgrades since 2010, 34.2% of EU resources will be contributed by MS rated 'AAA'/Stable in 2015 (primarily Germany, the largest contributor with 21.7% of EU resources, and to a lesser extent Netherlands, Sweden, Denmark, Finland, Luxembourg), and 96.3% by MS rated in the investment-grade category. Fitch also estimates that political support for the EU remains strong among MS despite protracted negotiations on budget approvals, as illustrated by the lack of material delays in budget contributions throughout the EU crisis.

Should budget revenues be insufficient to repay the EU's or Euratom's debt, MS are obliged by EU legislation to complement budget revenues, if necessary beyond their initial share in the EU resources, up to a maximum of 1.23% of EU GNI every year. Based on MFF projections, these additional contributions would amount to around EUR30bn, which are multiple times EU's yearly debt service over the MFF period, even under the conservative assumption that these additional contributions were only from MS rated 'AAA'/Stable and restricted to their current share in the EU resources.

Additionally, MFA's and Euratom's loans to neighbouring countries are partly protected by a guarantee fund, which also covers EU guarantees to loans made by the European Investment Bank (AAA/Stable) outside the EU. Although limited in size (it amounted to EUR2bn at end-2014), it could prove useful given the rising exposure of the EU to Ukraine (CC). Total exposure to this country was EUR1.4bn at end-2014, and could rise up to EUR3.4bn in the coming two years.