Scope affirms the Land of Berlin at AAA with Stable Outlook
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Scope Ratings GmbH (Scope) 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.
Summary and Outlook
The AAA rating reflects the highly integrated institutional framework under which the Land of Berlin operates and its conservative budgetary management, strict commitment to fiscal consolidation, excellent capital market access, favourable debt profile, prudent liquidity management and solid economic bnase. These supportive factors are balanced by challenges related to high direct debt, limited revenue flexibility, unfunded pension commitments weighing on long-term expenditure flexibility, as well as sizeable but manageable contingent liabilities.
The Stable Outlook represents Scope’s view that risks to the ratings over the next 12 to 18 months are balanced. The ratings could be downgraded if: i) the German sovereign rating was downgraded; and/or ii) changes were made that affect the institutional framework, resulting in notably weaker support.
Like all Germany’s Länder, the Land of Berlin benefits from a mature and highly integrated institutional framework. The key elements of the framework are: i) a strong revenue equalisation mechanism; ii) wide-ranging participation of the Länder in national legislation, including veto rights; iii) equal involvement of the Länder in negotiations on federal reforms; and iv) a solidarity principle that ensures extraordinary system support in a budgetary emergency. The strong integration in the co-operative federal system aligns the credit ratings of the German Länder with the rating of the federal government (AAA/Stable).
In an international context, Scope views the established German institutional framework, with a proven record of institutional support from the national government, as able to tackle the economic challenges and withstand the pressure on sub-sovereign finances caused by the Covid-19 crisis. Co-operation on the policy response between the German Länder and the federal level has been strong during the crisis. Also, the federal government has assumed the primary role as a stabiliser by implementing substantial deficit spending policies to absorb the costs of higher unemployment and support economic output.
The AAA rating is further supported by the Land’s conservative budget planning and accommodative financing conditions which have halved Berlin’s interest payment burden since 2012, strengthening its budgetary flexibility. Berlin’s track record of solid budgetary performance has been underpinned by controlled expenditure growth between 2012 and 2019, with high operating surpluses averaging 14.5% of operating revenues. The administration reacted promptly to the Covid-19 shock, making the necessary adjustments to strengthen budgetary flexibility for two years (2020 and 2021) and ensuring access to liquidity for the regional economy via direct fiscal support or liquidity assistance for the hardest-hit businesses.
At the same time, spending controls were reinforced, with Berlin’s 2020-2024 financial planning re-balanced by controlling personnel and other operating costs and re-prioritising investment activity. Still, after eight successive years of surpluses, Berlin reported a budgetary deficit (before debt movement) of EUR 1.4bn, or 3.6% of total revenues. Tax revenues were EUR 1.6bn lower than budgeted and additional pandemic-related costs (healthcare, transfers to businesses and fiscal support to some of the Land’s shareholdings) amounted to EUR 3.4bn, or 11% of operating expenditure, including funds from the federal government channeled via Berlin’s budget to support businesses affected by lockdowns.
Berlin benefits from a high share of investment relative to total expenditure (11% in 2019, down to 6% in 2020 due to the denominator effect given high pandemic-related expenses via federal and the Land’s support programmes), enabling some capital expenditure to be postponed. Berlin’s investment strategy is based on three pillars: i) the core budget; ii) a special infrastructure fund; and iii) infrastructure investments by the Land’s shareholdings, which improve budgetary flexibility. For 2021, Scope expects another deficit of around 5% of total revenues. This is due to the prolonged effect of lower-than-budgeted tax revenues, partly exacerbated by the lockdowns in early 2021 and corresponding reduced economic activity as well as additional pandemic-related expenditure. Over the medium term, Scope expects Berlin to report small budget surpluses and adhere to its long-term consolidation strategy, supported by conservative budgetary management, low financing costs, the option to adjust some spending in view of high investment levels, and its economic and demographic outperformance vis-à-vis national peers.
The AAA rating is further supported by Berlin’s excellent capital markets access and prudent liquidity management. In line with all Länder, Berlin’s market access remained excellent during the Covid-19 crisis as had been the case during the last global financial crisis, demonstrating investor confidence in the German framework. In addition, Berlin employs a conservative debt-management strategy with no foreign currency risks and limited interest rate risks. Going forward, in view of the low interest rate environment, Berlin’s debt management strategy foresees: i) no new foreign currency exposure; ii) the majority of issuance at fixed interest rates; and iii) limited and declining use of interest rate derivatives.
Scope views Berlin’s liquidity management as sound due to comprehensive inter-year cash planning and the availability of numerous sources of liquidity. Berlin upped its funding activity in 2020 in response to the pandemic. Funds not used in 2020 were placed in a reserve, thus increasing Berlin’s cash balance markedly at the end of 2020. Access to liquidity to bridge intraday needs, if required, is available through credit facilities from major financial institutions. An additional source of liquidity is provided by commercial cash transactions between the German Länder, which lend excess liquidity to each other. In combination with excellent market access, the risk of potential liquidity shortages is negligible.
Finally, the AAA rating is also supported by Berlin’s favourable economic and demographic long-term trends as well as its competitive advantages as an attractive location for international investors and successful businesses, particularly in the information and communication sector. The GDP-per-capita gap between the Land of Berlin and the German average was closed in 2019, and the figure now stands at 105.3% of the national average. Population growth has been strong, with an average 40,000 inhabitants added each year over 2011-2020, underpinned by net immigration from other European countries.
Like all German Länder, Berlin’s economy was significantly affected by the Covid-19 crisis in 2020, with real GDP declining by 3.3% (versus -4.8% for Germany as a whole). Berlin’s economic resilience was strengthened by sectors which were adaptable to the pandemic-related restrictions. A dynamically growing information and communication sector, the public sector’s above-average share in the creation of gross value added as well as an important pharmacy sector have partially compensated for the losses in the tourism and recreation sectors.
Due to Berlin’s recent economic and demographic outperformance vis-à-vis national peers and substantial support measures at the federal level, Scope expects a strong post-crisis recovery for the Land, of around 3.5%, in line with Germany as a whole. Following a temporary, pandemic-induced moderation of population inflow to 6,800 year-on-year in September 2020, Scope expects Berlin’s positive demographic trends to continue over the medium term, reflecting the metropolitan city’s attractiveness compared to other European capitals.
Despite these strengths, Berlin’s AAA rating is balanced by several challenges.
First, Berlin’s direct debt levels are high by national and international standards. In 2020, after eight years of debt reduction, Berlin’s budgetary response to the Covid-19 crisis caused direct debt to rise sharply by EUR 6.2bn, from EUR 57.6bn to EUR 63.7bn. This amounts to 208% of operating revenues, up from 199% in 2019 and above the Länder average of 144%, but still well below the 289% in 2012. In response to the Covid-19 crisis and in line with most other Länder, parliament invoked the safeguard clause of Berlin’s debt brake rule and adopted budgetary measures allowing for EUR 7.3bn of new debt issuance in 2020. The Land made use of the full envelope of issuance, and funds unused in 2020 of EUR 5.4bn (instead of the planned EUR 4.1bn) were placed in a reserve earmarked for expected tax revenue shortfalls and additional support measures.
To cover the expected deficit this year, Berlin plans to use funds from the EUR 5.4bn remaining in the reserve created for the pandemic in 2020. Scope expects Berlin’s debt burden to peak this year at about 215% of operating revenues and gradually decline in the coming years. The completion of remaining funding under the 2020 credit authorisation will increase Berlin’s nominal debt stock to EUR 65.9bn in 2021, above its previous peak in nominal terms in 2012. The redemption plan for debt incurred under the safeguard clause foresees annual instalments of EUR 270m between 2023 and 2049, leading to manageable additional debt service costs. Risks associated with the high debt level are mitigated by a favourable debt profile, excellent market access and long-term downward trend in interest rates.
Over the long term, Berlin faces high pension contributions to its civil servants. Pension payments amounted to 8% of total expenditure in 2020, which was below the national average of 9%. This is because after reunification, civil servants in the new Länder were not included in the pension scheme but in 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, resulting in largely unfunded pension commitments.
As for all German Länder, Berlin has low flexibility to adjust revenues with little room for revenue increases via own taxes. Berlin receives shared taxes in line with constitutional arrangements between the Länder and the Bund. 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, a high level of contingent liabilities is a notable credit challenge. However, in Scope’s opinion, this exposure is mitigated by the largely low-risk profiles of the companies partially or wholly owned by the Land of Berlin. While the Covid-19 crisis has adversely affected the profitability of some of Berlin’s holdings, which required financial support from the Land in 2020, the budgetary impact is limited. Scope views positively the entities’ low consolidated leverage ratio of 0.55 (total liabilities to assets).
Institutional framework assessment
Scope’s institutional framework assessment determines the intergovernmental integration between sovereign and sub-sovereign levels. Scope uses three key analytical factors to assess systemic support: i) institutionalised support; ii) fiscal interlinkage; and iii) political alignment between government tiers. The outcome of this assessment results in a downward rating range between the sovereign rating and the rating of the sub-sovereign entity of between 0 notches (high integration) and 10 notches (low integration).
Scope considers the institutional and financing framework under which the German Länder operate to display high integration for: i) institutionalised support; ii) fiscal interlinkage; and iii) political alignment. Consequently, Scope’s assessment results in an indicative downward rating distance of a maximum of one notch between the German sovereign (AAA/Stable) and the rating of an individual Land.
The results have been discussed and confirmed by a rating committee.
Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)
Scope assesses the individual credit profile based on a qualitative and quantitative analysis of four key risk categories: i) debt burden and liquidity profile; ii) budget performance and flexibility; iii) economy and social profile; and iv) quality of governance. This risk assessment is conducted on a scale from 1 to 100, whereby a high (low) score is associated with a strong (weak) credit profile.
Scope assesses Berlin’s individual credit profile as strong, reflecting the outcome of the quantitative Core Variable Scorecard and the qualitative assessment (QS) in the four respective categories as defined above (individual credit profile score equal to 59 of 100).
The review of potentially exceptional circumstances that cannot be captured by the quantitative and qualitative scorecards did not lead to further adjustments of Berlin’s indicative rating of AAA.
The results have been discussed and confirmed by a rating committee.
Factoring of ESG
Governance considerations are material to Berlin's rating and are included in Scope’s institutional framework assessment and its assessment of Berlin’s individual credit profile. These highlight the high quality of governance alongside the administration’s strict commitment to fiscal consolidation, conservative budgetary and liquidity management.
Social considerations are included in Scope’s assessment of Berlin’s ‘economy and social profile’, highlighting favourable demographics.
Alongside Scope’s assessment of rating-relevant credit risks, the rating agency also considered long-term environmental developments which did not play a direct role in this rating action.
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) budgetary performance and contingent liability risks; v) regional socio-economic and demographic developments; and vi) peer comparison.
The methodology used for these Credit Ratings and/or Outlooks (Rating Methodology: Sub-Sovereigns, 12 May 2021) is 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 rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary 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 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 definitions of default and 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 factor) are incorporated into the 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: the Rated Entity, public domain.
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 these 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/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead Analyst: Jakob Suwalski, Director.
Person responsible for approval of the Credit Ratings: Alvise Lennkh, Executive Director.
The Credit Ratings/Outlooks were first released by Scope Ratings on 14 July 2017. The Credit Ratings/Outlooks was/were last updated on 26 June 2020.
See http://www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.
Conditions of use / exclusion of liability
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