March 19 - 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 Short-term IDRs at 'F1+'. The Outlooks on the Long-term IDRs are Stable. KEY RATING DRIVERS The ratings of the EU and Euratom are primarily based on the strong support they receive from their 27 member states (MS) through committed and potential additional contributions to the EU budget in excess of the two institutions' yearly debt service obligations. Despite downgrades of MS in 2011 and 2012, the nine MS rated 'AAA'/'F1+' by Fitch at end-February 2013 contributed a 63% share of the 2013 EU budget. The ratings also take into account the highly conservative rules on loans and borrowings and the institutions' preferred creditor status. Although lending activity is not its main mission, the EU provides loans to sovereigns experiencing severe economic difficulties under three programmes. Macro-financial assistance (MFA) loans and balance of payment (BoP) loans are available for non-EU countries and EU non-eurozone MS, respectively, while loans under the European Financial Stabilisation Mechanism (EFSM) are available to all EU MS. In addition to this lending activity, the EU also provides guarantees to loans granted by the European Investment Bank ('AAA'/Negative) to countries outside the EU. Euratom's loans are dedicated to nuclear power projects in MS or neighbouring countries. Outstanding EU loans have increased significantly since 2008, up to EUR55.7bn at end-2012. This is mostly attributable to the EFSM programme, under which EUR48.5bn total loans to Ireland and Portugal were approved in 2010/2011 and are nearly fully disbursed. MFA and BoP loans outstanding are more moderate. Euratom's loans are much smaller, with outstanding loans declining to EUR423m at end-2012, concentrated in Romania, Bulgaria and Ukraine. The EU and Euratom's borrowings are exclusively dedicated to financing those loans. The EU budget cannot be financed by debt. Borrowings are matched to loans in terms of maturity, interest payments and currency, removing market risk. In addition, both entities have preferred creditor status: the repayment of their loans takes precedence over other creditors. EU debt repayment is protected by a guarantee fund covering losses on MFA and Euratom loans to third countries and on guarantees to the EIB, fed by the EU budget. It covered 8.7% of those activities at end-2012, and funds are managed conservatively. However, given the marginal share of those activities in EU total indebtedness, Fitch considers the benefits of this guarantee fund limited to support the repayment of EU bonds. Support provided by the EU budget is very strong. In case of a borrower default, the European Commission can tap into the EU budget's available resources transferred every month by MS, and prioritise debt repayment over other non-obligatory expenditures. If this proved insufficient, MS are obliged by EU legislation to provide additional contributions necessary to repay the debt and balance the budget, up to a ceiling of 1.23% of EU Gross National Income (GNI). If necessary, the EU legislation allows MS to contribute more than their share in the EU budget. Fitch deems that political support for the EU is very strong, ensuring that some large highly-rated MS would participate in such additional contributions. Given that MS contributions to the EU budget are expected to be less than 1% of GNI every year until 2020 (2013: 0.98%), an approximate additional 0.25% of EU GNI can be requested from MS every year by the EU to honour debt repayment, accounting for approximately EUR30bn a year. The EU ensures that yearly debt service never exceeds these potential additional contributions. In practice, based on end-2012 indebtedness, debt service is not expected to exceed EUR10bn a year until 2020 and should not materially increase given the phasing out of the EFSM programme and its replacement by the European Stability Mechanism ('AAA'/Stable). RATING SENSITIVITIES The Stable Outlook reflects Fitch's view that MS willingness and ability to support remains strong. More specifically, Fitch takes comfort from the fact that the expected yearly debt service of EU and Euratom until 2020 is fully covered by the additional contributions to the EU budget that could be provided by MS currently rated 'AAA'/Stable. Fitch would review the ratings of both institutions if there was a material deterioration in creditworthiness or political support by the highly-rated large MS, which include Germany ('AAA'/Stable), France ('AAA'/Negative) and the UK ('AAA'/Negative), and specifically if yearly debt service was no longer covered by potential additional contributions from MS currently rated 'AAA'/Stable. Furthermore, pressure on the rating would occur if yearly debt service of the EU increased significantly, or if the conservative risk management framework on indebtedness and loans were altered significantly. KEY ASSUMPTIONS The ratings and Outlooks are sensitive to a number of assumptions: - Fitch assumes that the risk of fragmentation of the eurozone remains low; - Fitch assumes that no large MS will choose to leave the EU and that member states 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 EU MS on a timely basis.