S&P: Rating On Supranational Institution The European Union Affirmed At 'AA'; Outlook Stable
We use our principles of credit ratings criteria to assess the EU as a supranational borrower, owing to the uniqueness of its structure. Although theEU lends to member states, the EU does not resemble a bank: it has no paid-in equity (nor, technically, any callable capital, although it can--as established in the Treaty of the European Union--call upon the resources of member states to service its debt). At the same time, our high credit rating partly recognizes the EU’s de facto preferred creditor treatment. The EU also benefits from several lines of explicit and implicit support by EU member states as stipulated in the Treaty of the European Union.
Unlike most financial entities, including the European Financial Stability Facility (EFSF)--another supranational that has lent to program countries in Europe--the EU does not engage in maturity transformation. All of its loans are equally matched back-to-back by same-maturity borrowings in the market. The EU lends primarily to member states via its European Financial Stabilization Mechanism (EFSM) lending to two members states, Ireland and Portugal (86.7% of the EU’s loan book), as well as to non-member states via its small-scale macrofinancial lending to Serbia, Bosnia, Macedonia, Albania, Armenia, and Ukraine. The EU also extends its guarantees to several European Investment Bank (EIB) lending programs.
The EU benefits from several credit strengths. The size of the EU's overall risk assets is limited when compared to EU-28 GDP (€13 trillion or 0.6%) or the EU government bond market (equivalent to €8.4 trillion or 0.9%). We also expect the EU's lending activities will likely gradually decline, now that theEuropean Stability Mechanism (ESM) is capitalized to provide financial assistance to eurozone member countries. Last year’s bridge loan from the EU to Greece for €7.2 billion was paid back on time and in full. The EU has no outstanding exposures to Greece (B-/Stable).
We expect that the average maturity at disbursement of the EU's EFSM loan portfolio will increase to 19.5 years (from 12.5 years in 2013), once it extends advances to Ireland and Portugal (assuming their governments make thisrequest as and when current loans from the EU come due). We anticipate that the EU will continue its back-to-back lending and that it will roll-over its debt to match the maturity extensions anticipated in the Irish and Portuguese Troika lending programs. We view as remote the EU not being able to access capital markets.
The EU's budget consists of annual revenues that we expect will total just under 1% of the total gross national income (GNI) of its member states (€1 trillion) over the 2014-2020 MFF. In case of need, a large part of these revenues could be reallocated for debt service instead of transfers and other current expenses. To ensure funds would be available in such a scenario, the EU has scheduled its debt maturities at the beginning of the month, when its cash balances are typically highest. Over the past two years, the beginning-of-month cash balance has been almost always higher than €10 billion; as of year-end 2015, cash and cash equivalents exceeded €21 billion or nearly three times the maximum yearly debt redemption of the EU over the next five years.
In addition to these recurrent cash receipts, the EU has a contingent claim ("fiscal headroom") on EU members, which we expect will average 0.28% of GNI (or about €30 billion annually) over the 2014-2020 MFF. EU members have made this pledge for the express purpose of backing the EU's financial obligations.
Both this pledge and any budgetary payments are joint and several obligations of EU members. We believe, however, that the willingness of sovereigns rated at or above the level of the rating on the EU to fulfill this joint and several pledge might be tested if some other members are unwilling to honor a capital call on a pro-rata basis.
The EU's annual budget is set according to the terms of the MFF. As part of the MFF, member states agree to commitments for individual budgetary line items and to disbursements under these commitments. The commitments and payments are both subject to ceilings.
In particular, the amounts paid in by EU members, from taxes and levies that fund the EU's commitments, must not exceed the MFF payment ceiling. As per an EU council regulation, these amounts paid into the EU's own resources account are adjusted retrospectively to reflect the actual value-added-tax base, as well as backward revisions to GNI as and when they are determined. Our rating on the EU reflects our assumption that member states will fulfil these obligations in accordance with retrospective revisions.
Germany, France, and the U. K. contribute 21%, 16%, and 13%, respectively, of net transfers to the EU budget, according to our estimates.
The stable outlook reflects our opinion that the rounded average GDP-weighted rating on the EU’s budgetary contributors will stabilize at current levels of ‘AA’ for the next two years under most possible scenarios, including a U. K. departure from the EU. This is the case even if the ratings on the two net contributing sovereigns with negative outlooks (excluding the U. K.) were both lowered (France: AA/Negative/A-1+; and Finland: AA+/Negative/A-1+). The stableoutlook also reflects our view that no other member states will leave the EU, and that the 27 remaining EU members will reaffirm their support to the EU andits key spending programs, although following a U. K. exit we expect the absolute level of spending will decline during the next MFF (2021-2027).
Rating pressure could build if the GDP-weighted average rating on net EU contributors continued to decline, or if we perceived more doubtful support from EU members for the union's key policies.
Rating upside appears remote at this point, but could come from a combination of a higher weighted-average rating on net EU contributors or strengthened political cohesion in the bloc.