OREANDA-NEWS. 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 of EU's and Euratom's unsecured bonds have been affirmed at 'AAA'.

The affirmation of EU's and Euratom's ratings reflects the continuing strong commitment from the 28 member states (MS) to honour their contributions to the EU's budget, and more specifically, the support of the 'AAA'-rated MS.

KEY RATING DRIVERS
EU's and Euratom's ratings and Stable Outlook reflect the following key rating drivers:

EU and Euratom are supranational administrative bodies. Their 'AAA' ratings reflect Fitch's view that their debt is ultimately backed by EU budget revenues. This relies on MS' ability and propensity to honour their budget commitments.

The EU's indebtedness (EUR56bn at end-2015) is only incurred for the purpose of on-lending to MS (through the balance of payments 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-2015) is dedicated to on-lending to MS or neighbouring countries to finance nuclear power projects. Lending activity for both institutions is funded outside the budget through dedicated borrowings made in the name of the EU and Euratom.

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), which defines budget orientations for 2014-2020, annual resources transferred by MS to the EU will average 0.97% of EU's gross national income (GNI) in the period 2014-2020.

EU MS may have to contribute to budget revenues, if necessary, beyond their initial share, up to a maximum of 1.23% of EU's gross national income every year. Under the assumption that MS would restrict their additional transfers to their current share in the EU resources, additional annual contributions from 'AAA'-rated MS would range from EUR10bn to EUR12bn in the period 2016-2020. This would cover the EU's and Euratom's combined yearly debt service, which is projected not to exceed EUR8bn, based on their actual loan portfolios during the same period.

In Fitch's view, MS' ability and willingness to contribute to the EU budget is strong. Despite several sovereign downgrades since 2010, the overall credit quality of EU countries remains high. Of the EU's budget national contributions for 2016 32.9% will be contributed by MS rated 'AAA' (Germany, Netherlands, Sweden, Denmark, Finland and Luxembourg). Political support to the EU and Euratom also remains strong, as illustrated by the lack of material delays in budget contributions throughout the EU sovereign debt crisis.

In Fitch's view, the potential for an exit vote by the UK in the referendum scheduled for 23 June does not have immediate implications for the ratings of the EU/Euratom, particularly given that the UK is not included in the group of 'AAA'-rated MS whose contributions underpin the EU's debt service. However, Fitch believes that a UK decision to exit could have longer-term negative implications for EU's creditworthiness if it results in a weakening of support for the EU by other highly rated MS. The potential for such a development would need to be assessed over the medium term as opposed to the immediate aftermath of the referendum outcome.

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) for the implementation of the EU external lending mandate. The fund represents about 9% of external commitments and could prove useful, for example if EU's exposure outside the union grows.

EU loans are extended to countries facing economic difficulties, predominantly EU MS. The largest single exposure is Portugal (BB+/Positive), and EU granted a one-month bridge financing to Greece in 2015 (already fully repaid). Exposure to non-EU countries, mostly Ukraine (CCC), but also Tunisia (BB-/Stable) is growing. The portfolio is highly concentrated. However, EU enjoys preferred creditor status equivalent to other multilateral development banks; it has never suffered a loss on its loan portfolio.

EU's and Euratom's loan features and maturities are aligned with their respective debt profile and this has remained so after the refinancing of debt following the extension of Ireland's loan maturity in 2015, as made possible by EU legislation.

RATING SENSITIVITIES
Negative: The factors that could, individually or collectively, result in negative rating action are:
- A downgrade of an existing 'AAA'-rated MS resulting in the annual debt service not being covered by potential additional contributions from MS rated 'AAA'
-Significant increase in the combined annual debt service of EU and Euratom as a result of higher lending, or if the quality of the risk management framework deteriorates significantly.

KEY ASSUMPTIONS
The ratings and Outlook are sensitive to a number of assumptions:
-MS will remain committed to paying their monthly contributions to the EU budget; therefore contributions to the EU budget are assumed to remain predictable and be provided by MS on a timely basis.

-No 'AAA'-rated MS will choose to leave the EU in the short- to medium-term.