Scope affirms Land of Berlin credit rating of AAA with Stable Outlook
Scope Ratings GmbH has today affirmed the Land of Berlin’s long-term issuer rating at AAA and short-term issuer rating at S-1+. The sub-sovereign’s senior unsecured debt is also affirmed at AAA. All ratings are expressed in both local and foreign currency. All Outlooks are Stable.
The latest information on the rating, including rating reports and related methodologies are available on this LINK.
The AAA rating reflects the strong support for Berlin from the German institutional framework, a strict commitment to fiscal consolidation, the firm downward trajectory and favourable profile of the Land’s direct debt, as well as prudent liquidity management. Challenges to the rating include legacy debt levels that remain high, unfunded pension liabilities and low fiscal flexibility given limited leeway to adjust revenues and expenditures. The Stable Outlook reflects Scope’s assessment that risks for the Land of Berlin remain well balanced.
The Land of Berlin’s AAA rating is underpinned by a very stable and supportive German institutional framework with a strong revenue equalisation system, together with the federal solidarity principle. This ensures a high degree of cohesion among the Länder, preventing them from getting into financial difficulties. This view is underpinned by the highly predictable cash flows, good access to short-term liquidity and deep capital markets, making liquidity risks negligible. It is Scope’s view that these factors align the credit profiles of the Länder and the federal government (the Bund, AAA, Stable Outlook).
Berlin’s sound budgetary performance has been underpinned by controlled expenditure growth since 2012 with high operating surpluses averaging 14.5% of operating revenues which enhanced Berlin’s ability not only to fund its operating expenses with operating revenue but to realise extra revenue to cover interest payments and some capital expenditure. The balance after investment activities and interest payments has remained positive since 2012 (averaging a surplus of 2.5% of total revenues), demonstrating Berlin’s strict commitment to fiscal discipline and supporting a gradual reduction of the Land’s direct debt.
In 2018, Berlin continued its good budgetary performance and outperformed its fiscal targets despite strongly rising demand for social services due to population growth. Berlin’s budgetary surplus rose to 5.1% of total revenue in 2018 from 3.1% in 2017, supported by higher-than budgeted tax revenues and solid expenditure management. For example, interest payments are budgeted on a conservative basis, social transfers to Berlin’s districts regularly include a buffer for contingency purposes and expenditure growth is capped by the growth of revenues to ensure compliance with debt brake rule requirements. In addition, investments were lower-than budgeted in 2018, reflecting capacity constraints of the regional construction sector.
Under the Land’s financial plan for 2018-2022, Berlin intends to sustain a high level of investments to address the city’s rapid growth while keeping balances before debt repayment positive. This underscores the commitment of the Land to avoid taking on new debt and comply with the debt brake rule starting in 2020. Scope expects budgetary surpluses to decline to around 2% of total revenue over the next years due to rising operating expenses and investments needed to address the city’s rapid growth and migration flows. Over the medium term, Scope expects Berlin to maintain its prudent budgetary policy, adhere to its fiscal consolidation strategy and remain compliant with the debt brake rule.
Scope views the Land of Berlin’s liquidity management as sound. Liquidity management plans are set for one year and based on predictable cash flows. While outflows are not subject to large deviations, Scope believes that inflows are calculated conservatively. Additional continued access to liquidity to bridge intraday needs, if required, is available through credit facilities from major financial institutions. Liquidity is also available from commercial cash transactions between the German Länder, which lend excess liquidity to each other, thus providing an additional source of liquidity. Combined with Berlin’s own prudent financial planning, this results in a negligible risk of potential liquidity shortage.
The Land of Berlin has a solid track record regarding access to capital markets. During the last financial crisis, access remained excellent, reflecting investor confidence in the German solidarity system. At the end of 2018, Berlin further lengthened its weighted debt maturity to 7.7 years, up from 7.6 years at the end of 2017. Scope views the Land’s debt profile as favourable, with debt reductions in combination with excellent market access resulting in a low average cost of outstanding debt of 1.8% in 2018. Lower net interest payments have more than halved the burden on the budget to 4.3% of operating revenues in 2018, down from 9.6% in 2012, providing some additional fiscal leeway.
The AAA is also supported by Berlin’s favourable economic and demographic trends. In 2018, Berlin's GDP expanded by 3.1%, outperforming the German average of 1.4%. Should growth continue to exceed the German average, the GDP-per-capita gap between the Land of Berlin and the German average will be further reduced. In addition, strong economic growth led to a reduction in the unemployment rate of the Land of Berlin, down to 8.1% in 2018 from 12.3% in 2012.
Despite these strengths, Berlin faces several challenges. Berlin’s debt burden is high by both national and international standards, despite the firm downward trend since 2010. Direct debt amounts to EUR 57.6bn or 196.3% of operating revenues as of end-2018, down from 213% at end-2017. Similarly, debt service is on a declining trend but remains high at EUR 7.7bn in 2018 or 27.1% of operating revenues in 2018, significantly down from EUR 9.7bn or 44.6% in 2013 and mitigated by excellent access to capital markets. The robust growth of operating revenues, solid expenditure management, conservative budgetary policy and refinancing strategy have resulted in sustained budgetary surpluses that have enabled this downward trend. Scope expects this downward trend to continue, in keeping with the Land’s medium-term financial planning
Over the long-term, Berlin faces high pension contributions to its civil servants. Pension payments amounted to 8.1% of total expenditure in 2017, which was below the national average of 11.3%, given the fact that after reunification, civil servants in the new Länder were not included in the pension scheme, but rather treated based on a pay-as-you-go-system under the Pension Transition Act. To ease the pressure from pension obligations, Berlin provides mandatory payments to the pension contribution plan, which are expected to reach around EUR 1.2bn in 2019, resulting in largely unfunded pension liabilities. In 2018, the Land of Berlin has assigned an external reviewer to calculate the size of its future pension obligations. The actuarial results conclude that obligations are currently at EUR 57bn, a substantial increase from the previously assumed EUR 35-40bn.
The Land of Berlin also faces the challenge of low fiscal flexibility given limited leeway to adjust revenues and expenditures. This flexibility remains constrained by the fact that most expenditures result from rigid personnel and transfer payments. In line with constitutional arrangements between the Länder and the Bund, Berlin receives shared taxes. These revenues initially flow into Berlin’s budget but are later redistributed at a national level in accordance with revenue-sharing agreements and additional transfer mechanisms, essentially weakening their link to the Land’s economic performance.
Finally, due to the extensive shareholdings of the Land of Berlin, the high level of contingent liabilities is also a concern, which, however, is mitigated by the largely low-risk profiles of the companies that the Land of Berlin partially or wholly owns. Scope views positively the entities’ consolidated low leverage ratio of total liabilities to assets of 0.51 and continuous profitability. This ratio accounts for an increase in the consolidated debt of the major entities, excluding the regional promotional bank ‘Investitionsbank Berlin’, to EUR 16.8bn in 2018 from EUR 16.2bn in 2017. This increase is somewhat offset by the high level of assets, in part due to the Land’s shareholding in the real estate and housing sectors, which have experienced a rise in value. It is Scope’s view that the associated companies fulfil a significant public-sector mandate for the Land of Berlin by contributing to the further development of Berlin’s dynamic growth, as well as strengthening the regional economy.
Outlook and rating-change drivers
The Stable Outlook reflects good visibility on the evolution of the very supportive German institutional framework and Scope’s expectation that Berlin’s government will keep to its fiscal consolidation programme and continue to place the Land’s debt on a firm downward trajectory over the medium term.
The ratings could be downgraded if: i) the German sovereign rating were to be downgraded or ii) changes in the institutional framework resulted in notably weaker support.
The main points discussed during the rating committee were: i) the institutional framework; ii) budgetary performance and fiscal flexibility; iii) Berlin’s economic structure; iv) debt developments; v) contingent liabilities; vi) pension liabilities; and vii) peers comparison.
The methodology applicable for this rating and/or rating outlook is "Rating Methodology: Sub-Sovereign 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. 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 http://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.
Solicitation, key sources and quality of information
The rated entity participated in the ratings process.
The following substantially material sources of information were used to prepare the credit rating: the rated entiy, public domain. Key sources of information for the rating include: Senatsverwaltung für Finanzen Land Berlin, Bundesfinanzministerium, Statistisches Bundesamt, historical figures on budget implementation, actual financial figures, budget for the next year and multi-year budget forecasts, historical outstanding debt, debt obligations and guarantees, list of sponsored entities, socio-economic statistics.
Scope considers the quality of information available 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.
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst Jakob Suwalski, Associate Director
Person responsible for approval of the rating Dr Giacomo Barisone, Manging Director
The ratings /outlook were first assigned by Scope in 14.07.2017.
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