Scope assigns Land of Berlin credit rating of AAA with Stable Outlook (Correction)
Scope Ratings AG today assigns the Land of Berlin a long-term issuer rating of AAA in both local and foreign currency. The agency also assigns a short-term issuer rating of S-1+ in both local and foreign currency. The Land’s senior unsecured debt in both local and foreign currency was also rated at AAA. All Outlooks are Stable.
The AAA rating reflects the very supportive German institutional framework under which Berlin operates, the commitment to fiscal consolidation, the firm downward trajectory and favourable profile of the Land’s direct debt, and strong liquidity management. However, these supportive factors are balanced by challenges related to still-high direct debt and limited financial flexibility, which is mitigated in part by a growing proportion of more flexible capital expenditures. In addition, though contingent liabilities of the City are sizeable, they largely carry low risk for Berlin’s balance sheet. The Stable Outlook reflects Scope’s assessment that the risks the Land of Berlin faces remain fairly balanced.
The Land of Berlin’s AAA rating is underpinned by a very supportive German institutional system characterised by a very strong revenue equalisation mechanism, a legally tested extraordinary support mechanism, a safe and predictable cash management system designed to guarantee efficiency and liquidity at any point in time, and access to deep capital markets. It is Scope’s view that these factors align the Länder and the federal government (the Bund, AAA, Stable Outlook) credit profiles.
After years of successive deficits, Berlin’s budgetary performance has improved substantially. Its current balance turned positive in 2012 and has since increased to 8.5% in 2016 from 5% in 2012. The Land was able to realise a positive current balance thanks to a markedly strengthened operating balance, which rose to 14.7% in 2012 compared to 8.2% and 8.5% in 2010 and 2011, respectively. This improved operating balance enhanced Berlin’s ability not only to fund its operating expenses with its operating revenue but to realise extra revenue to cover interest payments and some capital expenditure. Significantly, the balance before debt, which also became positive in 2012, has remained in positive territory since then, supporting a gradual reduction of the Land’s direct debt from 288.8% in 2012 to 234.2% in 2016. Scope expects the Land to continue its prudent budgetary policy in future, which will prevent Berlin from taking on new debt.
Berlin benefits from sound liquidity management, the key elements of which are thorough inter-year cash planning and the availability of various sources of liquidity. The sources of liquidity include cash transactions among the German Länder, which place their excess liquidity among themselves and act as lenders, as well as transactions with commercial banks and the German federal treasury. The Land’s legal money market authorisation is 13% of budgeted revenue, or around EUR 3bn1.
Berlin has an excellent track record of solid capital market access with improving market financing conditions. At year-end 2016 Berlin was able to lengthen its weighted maturity debt profile to 7.1 years compared to 6.7 years at year-end 2015 and decrease its cost of funding to annual average of 1.95% in 2016 from 3.3% in 2010. Berlin has favourable debt profile predominately made up of bond issues, though bank loans still play a role (about a third of the total direct debt).
In 2016 Berlin's GDP expanded by 2.7%, outperforming the federal average of 1.9%. Should growth continue above the national average, the GDP-per-capita gap would reduce even further. In addition, strong economic growth led to a reduction in the Land’s unemployment rate, to 9.8% in 2016 from almost 12% in 2012. This momentum has helped to substantially reduce structural long-term unemployment by 34% since 2012.
Despite these strengths, the rating is constrained by a number of challenges. Though the level of the Land’s direct debt is very high by national as well as international standards, it has been on a firm downward trend since 2010. At the end of 2016 Berlin’s direct debt stood at EUR 59.4bn, or 234% of operating revenue. Positive balances before debt and buoyant operating revenue growth have so far been the driving forces behind this trend. Under Berlin’s medium-term financial plan until 2020 Scope expects this downward trajectory to continue, with debt reaching slightly above 200% to operating revenue at year-end 2020.
The Land’s operating expenditures mostly comprise staff expenditures and various subsidies, thus reducing flexibility over spending. However, a rising portion of overall capital expenditure still indicates some degree of flexibility. The high level of contingent liabilities is also a concern. Together with direct debt and guarantees, this amounts to 387% of the Land’s operating revenue as at the end of 2016, but is mitigated somewhat by the largely low-risk profile of the entities that the Land partially owns.
Outlook and rating-change drivers
The Stable Outlook reflects Scope’s expectation that Berlin’s government will keep to its fiscal consolidation programme and also continue to place the Land’s debt on a firm downward trajectory over the medium term.
The ratings could come under negative pressure if: i) the German sovereign rating were to be downgraded or ii) significant material changes were to affect the institutional framework.
1Editor's note: The above section was corrected on 17 July 2017 following the publication of the credit rating action on 14 July 2017. The original wording was: The sources of liquidity include cash arrangements among the German Länder, which place their excess liquidity among themselves and act as lenders, as well as credit lines with the German federal treasury and a number of commercial banks. The Land’s limit with federal treasury is 13% of budgeted revenue, or around EUR 3bn, which has never been fully used.
For the detailed rating report please click HERE.
The main points discussed during the rating committee were: (1) the impact of the recent reform of equalisation system on the institutional framework, (2) Berlin’s budgetary performance and debt sustainability developments, (3) the liquidity cash management and access to capital markets, (4) Berlin’s exposure to contingent liabilities, (5) the double status of city-land and General Government capital, (6) peers consideration.
The methodology applicable for this rating and/or rating outlook is “Public Finance Sub-Sovereign Credit Rating”.
Historical default rates of Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/governance-and-policies/regulatory/esma-registration. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default, definitions of rating notations can be found in Scope’s public Credit Rating methodologies on www.scoperatings.com.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.
This credit rating and/or rating outlook is issued by Scope Ratings AG.
Rating prepared by Dr Ilona Dmitrieva, Lead Analyst
Person responsible for approval of the rating Dr Stefan Bund, Chief Analytical Officer
The ratings /outlook was first assigned by Scope in 14 July 2017.
The senior unsecured debt ratings as well as the short term issuer ratings were assigned by Scope for the first time.
Deviation of the publication of sovereign ratings or related rating outlooks from the calendar shall only be possible where necessary for the credit rating agency to comply with its obligations under Article 8(2), Article 10(1) and Article 11(1) and shall be accompanied by a detailed explanation of the reasons for the deviation from the announced calendar. In this case the deviation was due to the issuer’s request to assign a public credit rating and in order to meet the requirement to disclose these ratings in a timely manner, as required by the Article 10(1) of the CRA Regulation.2
2 Editor's note: The above paragraph was corrected on 17 July 2017 following the publication of the credit rating action on 14 July 2017. The original wording was: Deviation of the publication of sovereign ratings or related rating outlooks from the calendar shall only be possible where necessary for the credit rating agency to comply with its obligations under Article 8(2), Article 10(1) and Article 11(1) and shall be accompanied by a detailed explanation of the reasons for the deviation from the announced calendar. The following sentence was added: In this case the deviation was due to the issuer’s request to assign a public credit rating and in order to meet the requirement to disclose these ratings in a timely manner, as required by the Article 10(1) of the CRA Regulation.
Solicitation, key sources and quality of information
The rating was requested by the rated entity. The rated entity participated in the ratings process. Scope had access to accounts, management and/or other relevant internal documents for the rated entity.
The following material sources of information were used to prepare the credit rating: data provided by the rated entity and in public domain. Scope considers the quality of information provided to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued
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