Frankfurt am Main, March 14, 2014
Moody’s Investors Service has today changed the outlook to stable from negative on the European Union’s (EU) Aaa rating. Concurrently, Moody’s has affirmed its Aaa/(P)Prime-1 ratings.
The key drivers of today’s outlook change are as follows:
- The improvement in the creditworthiness of the EU’s largest shareholders, which it depends on for additional support in high stress scenarios.
- Diminishing risks emanating from the euro area debt crisis, which alleviates pressure on asset quality.
The key drivers for today’s affirmation of the EU’s Aaa/(P)P-1 ratings are:
- The joint and several liability of member states with regard to their obligations to the EU.
- The EU’s multi-layer debt-service protection.
- The EU’s conservative budget management.
In a related rating action, Moody’s also changed to stable the outlook on the European Atomic Energy Community’s (Euratom) Aaa long-term ratings, on whose behalf the European Commission is also empowered to borrow. Concurrently, Moody’s has affirmed its Aaa/(P)Prime-1 ratings. Euratom’s key credit characteristics are identical to the EU’s, particularly the backing by the EU’s budgetary resources and by the European Commission’s right to call for additional resources from member states if needed. Hence, Euratom’s ratings tend to move in line with the EU’s.
RATIONALE FOR THE STABLE OUTLOOK
The first driver supporting the stable outlook is the improvement in the credit standing of the largest shareholders that the EU relies on for additional support in a high stress scenario, particularly following the improvements of Moody’s outlooks on the ratings of Germany (Aaa stable),the Netherlands (Aaa stable), Belgium (Aa3 stable) , Italy (Baa2 stable) and Spain (Baa2 positive). Together, 80.5% of the contributions to the EU’s budget now come from countries with a stable or positive outlook, compared to 22.0% when a negative outlook was assigned to the EU’s rating in September 2012.
The second driver for the stable outlook is reduced downside risk to the EU’s outstanding loans. Given that the EU’s loans are funded back-to-back in capital markets, recent rating actions on peripheral countries — particularly on Ireland (Baa3 positive) and Portugal (Ba3 stable) — indicate a diminished risk that they will fail to honour their obligations to the EU. Moody’s notes that Ireland and Portugal received the bulk of their loans under the European Financial Stabilisation Mechanism (EFSM; EUR43.8 billion out of a total amount granted of EUR48.5 billion) and account for around 78% of total EU outstanding loans (EUR55.76 billion).
RATIONALE FOR THE AFFIRMATION
The first driver of the affirmation is the joint and several liability of member states to their EU obligations. In the event that a borrowing member state fails to repay a loan on time and the EU’s own resources are insufficient to service the debt, the EC has the right to draw on all member states in order to make up for the shortfall — Article 323 of the Treaty on the functioning of the EU legally obliges member states to provide funds to meet all of the EU’s obligations in respect of third parties. Moreover, if the EU needs to call for additional resources from member states beyond the contributions outlined in the annual budget, the amount it calls from each member does not have to be proportional to that member’s contribution to the EU budget. In this context, the strong support for the EU evident among the member states is critical to its rating.
The second driver is the EU’s multi-layer debt-service protection given: (1) the borrowing country’s commitment to repay its loan (the funds raised are lent back to back, and the borrowing country pays down the interest and loan principal); (2) the EU’s vast budgetary resources relative to its debt obligations; and (3) the European Commission’s right to call for additional resources from member states, if needed.
The third driver of the affirmation is the EU’s conservative budget management. The European Commission (EC) is responsible for EU budget drafting and implementation, subject to approval by the Council and the European Parliament (EP). The EU Treaty requires the EU to balance its budget, prohibiting any borrowing to cover budgetary shortfalls. In addition, the EU’s Multiannual Financial Framework (MFF) provides the general framework for a seven-year period and establishes a ceiling for total expenditures for the annual budgets during that period. All borrowings by the EC are ultimately guaranteed by the EU, either through its budget or in the form of the EC’s right to draw on all member states to cover any shortfalls. In this context, the EU may defer budget expenditures to accommodate its debt service.
— WHAT COULD CHANGE THE EU’S RATING – DOWN
Risks to the creditworthiness of the EU and to its rating include a deterioration in the creditworthiness of the EU member states, as reflected in downgrades of Moody’s ratings for these states. The EU’s rating is particularly sensitive to changes in the ratings of the four countries rated Aaa or Aa1 that make large contributions to the EU budget (i.e., Germany, France, the UK and the Netherlands). A weakening of the commitment of the member states to the EU and changes to the EU’s fiscal framework that would lead to less conservative budget management would also be credit negative.
Specific economic indicators as required by EU regulation are not applicable for these entities.
On 11 March 2014, a rating committee was called to discuss the rating of the European Union. The main points raised during the discussion were: The issuer’s asset quality has increased. The ability of the EU’s shareholders to support the EU has increased.