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Rating action

Scope Ratings GmbH (Scope) has affirmed the A-/Stable issuer rating of Vonovia S.E. and its financing subsidiary Vonovia Finance B.V., along with the A- senior unsecured debt rating, BBB subordinated (hybrid) debt rating, and S-1 short-term rating.

Rating rationale

The rating affirmation follows Vonovia’s announcement to sign a business combination agreement with Deutsche Wohnen S.E., planned to be finalised by Q3 2021. The EUR 16.5bn tender offer for up to 89.9% in Deutsche Wohnen shares, along with EUR 2.1bn in convertible bonds (at the current conversion price) and EUR 0.6bn in transaction costs, will be financed by EUR 19bn in cash that is fully secured by committed bridge financing (up to EUR 22bn). The bridge financing will be refinanced through capital markets instruments (including senior bonds, hybrid and equity-like instruments), straight equity (in line with current authorisations), the disposal of 20,000 residential units to the City of Berlin via municipal housing companies, and further disposals¹.

The transaction’s successful execution would benefit the company’s business risk profile assessment (currently at A). This is based on the following considerations:

Low-risk industry (credit-neutral). The combined entity remains primarily exposed to the low-risk regulated residential real estate industry and the low-risk healthcare business (estimated at 92% of the combined entity’s reported EBITDA). In addition, disposals of selected parts of the high-risk real estate development business (4%) are anticipated in the coming months.

Improved market position (credit-positive). The Scope-adjusted total assets of the combined entity are anticipated to reach close to EUR 90bn (+40%)², while Vonovia’s number of residential units will jump to around 519,000 (+25%)³. Therefore, the transaction will make Vonovia the largest residential real estate landlord in Europe and the second-largest listed real estate corporate in the world by market capitalisation, improving its visibility on investment markets and access to capital markets.

Increasing geographic concentration (credit-negative). The addition of Deutsche Wohnen’s portfolio will significantly increase Vonovia’s exposure to Berlin and its regulatory framework (26% for the combined portfolio’s residential units⁴; 10% for Vonovia stand-alone). Vonovia is making efforts to mitigate this risk by seeking to appease stakeholders to the transaction, e.g. by giving the City of Berlin the option to buy around 20,000 residential units⁵. In addition, the share of non-domestic rental income is anticipated to decrease to around 14% (-5pp), thus increasing the concentration on the German regulatory framework. However, Scope believes Vonovia will pursue further European expansion, growing its share of non-domestic rental income to above 15% in the medium term.

Increasing share of strong growth locations (credit-positive). Asset quality is set to improve as Deutsche Wohnen’s portfolio focuses on regions with favourable demand-supply mechanisms: an estimated 70% of the combined portfolio’s residential units are in regions whose populations are forecasted to increase by at least 2.5% (+9pp); 41% (+15pp) of units are estimated to be located in ‘A’ cities. Both will ensure stable demand from tenants and investors, thus protecting the top line.

Stable profitability (credit-neutral). The combined entity’s profitability measures will be similar to those forecasted for Vonovia as a stand-alone entity. Expected synergies of around EUR 105m (run-rate) should help keep the Scope-adjusted EBITDA margin at around 75%.

Scope expects Vonovia’s financial risk profile to remain at BBB following the cash-financed transaction. The combined entity’s credit metrics are expected to benefit from Deutsche Wohnen’s leverage and debt protection levels (respectively, 34% Scope-adjusted loan/value ratio as at March 2021 and 4.9x EBITDA interest cover for the 12 months ending in March). Vonovia is also committed to keeping its loan/value ratio below 45%. The company explicitly states that deleveraging after the transaction will occur through a substantial capital increase and the disposal of up to 45,000 residential units – though this is still subject to execution risk. Thus, Scope forecasts post-acquisition credit metrics to remain broadly in line with the current rating scenario. Deleveraging will be further supported by disposals of selected development projects as well as potential value appreciations, thus increasing the headroom under the current rating scenario.

The potential execution of change-of-control clauses for Deutsche Wohnen’s capital markets debt (EUR 6.3bn as at end-March 2021)⁶ could pose some immediate liquidity risk, though Vonovia can bridge this with available liquidity (EUR 1.4bn in cash, pro-forma, as at end-June 2021 for the combined entity, EUR 1.0bn in committed undrawn credit facilities, and a EUR 5.6bn refinancing bridge facility). Furthermore, Vonovia does not expect secured bank debt (EUR 6.4bn) to be put due to change-of-control clauses.

Outlook and rating-change drivers

The Outlook for Vonovia remains Stable and incorporates Scope’s expectation of a successful acquisition of Deutsche Wohnen in Q3 2021 along the aforementioned terms and conditions. This would keep credit metrics constant in the medium term, with the Scope-adjusted loan/value ratio and Scope-adjusted debt to Scope-adjusted EBITDA anticipated to respectively reach around 40%-45% and 15x by YE 2022 following post-transaction peaks.

A negative rating action is possible if the Scope-adjusted loan/value ratio increased above 45% on a sustained basis. This could be triggered by i) a failure to deleverage after the transaction in the event the increase in capital and/or disposal proceeds are inadequate; ii) a change in financial policy; or ii) a significant drop in portfolio value following an adverse change in German regulations.

A positive rating action is unlikely but could be warranted if the Scope-adjusted loan/value ratio reached below 40% and Scope-adjusted debt to Scope-adjusted EBITDA fell to around 8x, both on a sustained basis, due to a change in capital allocation or a reduction in both expansion capex and shareholder remuneration.

Long-term and short-term debt ratings

As at end-March 2021, Vonovia had partially utilised a EUR 30bn EMTN programme with all issuances guaranteed by Vonovia S.E. Senior unsecured debt benefits from an unencumbered asset ratio of more than 200%, as disclosed by the issuer, which provides a pool of collateral to debt holders.

Vonovia has also issued EUR 1bn in hybrid bonds. Scope has granted a 50% equity credit for the subordinated, unsecured and perpetual EUR 1bn hybrid bonds that benefit from possible coupon deferral.

The S-1 short-term rating is supported by the better-than-adequate internal liquidity, good banking relationships, strong access to diverse funding sources and access to undrawn, committed credit lines, which Scope believes allow the company to address short-term refinancing needs. Vonovia had a non-utilised EUR 1bn commercial paper programme as at end-March 2021.

1. Includes up to 25,000 units and selected development projects in markets where Vonovia has very large exposure in relation to its local market size.
2. Includes around EUR 2bn in goodwill and excludes portfolio of 45,000 residential units to be sold
3. Assuming disposal of 45,000 residential units by YE 2021
4. Assuming the disposal of 20,000 units to the city of Berlin
5. Agreement to limit regulated market rent growth for existing tenants in Berlin to 1% on average annually for the next three years and in line with inflation thereafter until 2026; commitment to build at least 13,000 apartments in Berlin in the coming years
6. EUR 2.1bn in convertible bonds (at current conversion price), EUR 2.2bn in bonds and EUR 1.9bn in private placements

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for these Credit Ratings and Outlooks, (Corporate Rating Methodology, 26 February 2020; Rating Methodology: European Real Estate Corporates, 15 January 2021), are available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings’ internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed
Lead analyst: Philipp Wass, Executive Director
Person responsible for approval of the Credit Ratings: Olaf Tölke, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 13 December 2019. The Credit Ratings/Outlooks were last updated on 17 August 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings. Scope provided the following ancillary services to the rated entity and/or its agents within two years preceding this credit rating action: Rating Assessment Service.

Conditions of use/exclusion of liability
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