Scope rates the Free State of Bavaria at AAA with Stable Outlook
Scope Ratings GmbH has today affirmed the Free State of Bavaria’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.
For a detailed Rating Report, use this link.
The AAA rating reflects the Free State of Bavaria’s wealthy economy, strong budgetary performance, low debt burden, ample liquidity, excellent access to capital markets, and an integrated institutional framework. These supportive factors are balanced by challenges related to limited revenue flexibility, high pension liabilities weighing on long-term expenditure flexibility, and sizeable, yet manageable, contingent liabilities. The Stable Outlook reflects Scope’s assessment that the risks Bavaria faces remain well balanced.
Bavaria benefits from a wealthy, well-diversified and highly competitive economy, which contributed 18% of German GDP in 2018. This results in a high regional growth potential and a strong ability to consistently generate its own revenues. Bavaria is one of the wealthiest regions in Europe: in 2018, its GDP per capita outperformed both the German average, by around 17%, and the euro area average, by 40%. Bavaria enjoys favourable labour market characteristics and positive demographics, further supporting the state’s tax revenue potential. Due to constant job creation, unemployment continues to fall, down to 2.9% in 2018, and remains the lowest of the 16 German Länder.
The AAA rating also reflects the prudent fiscal management by the Bavarian administration. The Land’s budgetary performance has been strong. Between 2012 and 2017, operating surpluses averaged 12.8% of operating revenues, and significant surpluses before debt movement averaged 3.9% of total revenues despite high investment levels vis-à-vis national peers. Such performance has been underpinned by the strong growth in tax revenue, continuous cost control and conservative budget management. These factors have also helped to substantially reduce direct debt and build up substantial cash reserves. Based on recent tax estimates and in view of Bavaria’s conservative budgetary management, Scope forecasts that the Land will significantly exceed its 2018 budget, driven by strong tax revenue growth. Therefore, Scope expects a further improvement in Bavaria’s budgetary performance for 2018, with an operating surplus of around 15% of operating revenues (from 12.3% in 2017) and a sizeable surplus before debt movement of around 7% of total revenues, from around 5.2% in 2017.
According to Bavaria’s financial plan for 2018-22, the Land intends to increase its already high level of investment, from 12.4% of expenditure in 2018 to 14.2% in 2022, to be financed predominantly by the current balance and continue with significant debt reduction at the same time. In Scope’s opinion, the slower expected growth for tax revenue in 2020-21, which mirrors the anticipated national economic slow-down, should be mitigated by Bavaria’s i) economic and demographic outperformance vis-à-vis national peers; ii) conservative tax revenue growth assumptions and the possibility for budgetary adjustments, given the high investment expenditure; and iii) low and declining debt service costs combined with solid liquidity.
Bavaria’s debt burden is very low by national and international standards. In addition, Bavaria has repaid all maturing debt without recourse to credit authorisations in recent years. In 2012-18, Bavaria significantly reduced its legacy debt to EUR 15.9bn or to around 25% of operating revenue, down from 64% in 2012. Scope expects the debt burden to continue to decline, to around 15% of operating revenue by 2022, given that Bavaria has budgeted EUR 3bn for debt repayment in 2019-22. This will also result in a further decline in debt service, strengthening the Land’s fiscal leeway.
As for all German Länder, Scope assesses Bavaria’s access to capital markets as excellent. This was particularly evident during the last financial crisis, when all Länder maintained their excellent access, demonstrating investor confidence in the German framework. Bavaria’s debt-management strategy is also prudent, with no foreign currency exposure, limited interest rate risks and a relatively long maturity of its direct debt, which reduces refinancing risk. Going forward, in view of the low interest rate environment, Bavaria’s debt management strategy foresees the issuance of fixed-rate debt only.
Bavaria’s AAA rating is further underpinned by the Land’s sizeable cash reserves, vis-à-vis other German Länder, stemming from its sound budgetary and financial management, comfortably covering debt service through to 2020. Access to external liquidity, if required, is available at short notice through credit facilities from various major financial institutions. Combined with Bavaria’s own sizeable reserves, this makes the risk of a liquidity shortfall negligible. While Bavaria is likely to use some of its liquidity reserves for net debt repayment and to finance strategically important expenditure programmes, Scope expects liquidity reserves to remain very robust.
Finally, the Free State of Bavaria, like all German Länder, benefits from a mature and strongly integrated institutional framework. The key elements of the framework are: i) a strong revenue equalisation mechanism; ii) wide-ranging participation- and veto-rights by the Länder in national legislation; iii) equal entitlement of the Länder regarding negotiations on federal reforms; and iv) a solidarity principle that ensures extraordinary support in situations of budgetary emergency. The strong integration in the cooperative federal system aligns the credit ratings of the federal government (AAA/Stable) with the German Länder.
Bavaria has a unique role in the national political landscape. It is the only Land with a separate party: the Christian Social Union in Bavaria, or the CSU. The CSU has been in power since 1957 under different coalitions but usually as a one-party government and has always appointed the Land’s prime minister. The party also has a long-standing agreement with the Christian Democrats (CDU) to co-operate in federal and regional elections. While the CDU does not compete with the CSU in Bavaria, the two parties form a common parliamentary party at the national level increasing Bavaria’s influence on national policy-making relative to the other Länder.
Despite these strengths, the rating is balanced by several challenges. As most taxes are subject to revenue equalisation, Bavaria mainly receives shared taxes (largely personal income taxes, value-added taxes and corporate taxes). This limits revenue flexibility and weakens the link between tax revenues and the Land’s economic performance, given that Bavaria is the largest contributor to the German equalisation system.
Challenges also relate to Bavaria’s sizeable though low-risk contingent liabilities, mainly due to its 75% shareholding in BayernLB. Financial risk stemming from the Land’s exposure declined in 2017, after BayernLB repaid in full its state aid. The bank’s balance sheet is strong with a comfortable CET1 capital ratio of 15.2% in 2018, well in excess of the regulatory requirement. In addition, Bavaria’s strong management of its shareholdings is reflected in overall good annual financial results, indicating a low risk of materialisation of related debt contingencies.
Finally, over the long term, Bavaria’s budget is burdened by high pension payments, weighing on expenditure flexibility. To ease the rising pressure from unfunded pension obligations (expected to increase up to 13.5% of expenditure), Bavaria plans to co-finance pension payments via: i) savings through structural changes to the pension age and compensation levels; ii) continuous debt reduction, thereby generating some fiscal room; and iii) withdrawals from its pension fund. Overall, the combined measures, including the anticipated savings, would result in a moderate share of pension expenditure, peaking at below 10% and thus similar to today’s levels.
Long-term environmental and social risks
Alongside our assessment of rating-relevant credit risks, we consider long-term environmental and social developments. We assess developments regarding the German Länder by using selected sustainability indicators as defined by the German Sustainability Strategy (DNS), which itself is based on the Sustainable Development Goals (SDGs) set by the United Nations for 2030.
With regards to environmental indicators, Bavaria remains below the average of German Länder in terms of greenhouse gas emissions, primary energy consumption and renewable energy use. The Land has also failed to meet DNS targets, particularly related to the reduction of greenhouse gas emissions (11% against a 40% benchmark). Although the latest figures are from 2014, Bavaria is unlikely to meet the benchmarks by next year.
With regards to social indicators, Bavaria excels in educational attainment. The state outperforms the German Länder average not only in the share of early school-leavers but also in the proportion of students with at least an upper-secondary education. Bavaria has also outperformed on set benchmarks. At the same time, the Land fails to meet benchmarks on compatibility of family and career as well as on the gender pay gap.
Outlook and rating-change drivers
The Stable Outlook reflects Scope’s assessment that the risks Bavaria faces remain balanced.
The ratings could be downgraded if: i) the German sovereign rating were to be downgraded; or ii) changes were to affect the institutional framework, resulting in a notably weaker individual credit profile.
The main points discussed by the rating committee were: i) institutional framework for German Länder; ii) liquidity profile and debt burden; iii) debt management strategy; iv) contingent liability risks; v) regional socio-economic and demographic developments; vi) peers comparison.
The methodology applicable for this rating and/or rating outlook, Sub-Sovereign Credit Rating, published on 7 June 2019, is available on www.scoperatings.com.
Historical default rates of the entities rated by 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/cerepweb/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as 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.
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 entity, public domain. Key sources of information for the rating include: Staatsministerium der Finanzen und Heimat, Bundesfinanzministerium, Statistisches Bundesamt, historical figures on budget implementation, actual financial figures, budget for the next years, 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: Rating prepared by Jakob Suwalski, Associate Director.
Person responsible for approval of the rating Dr Giacomo Barisone, Managing Director.
The ratings/outlook was first released by Scope on 12 July 2019.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on the Free State of Bavaria are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2019" published on 04.02.2019 on www.scoperatings.com. Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case the deviation from Scope’s published calendar was due to the first-time release of the ratings.
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.
Conditions of use / exclusion of liability
© 2019 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions 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. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5 D-10785 Berlin.
Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Directors: Torsten Hinrichs and Guillaume Jolivet.