The associated full rating report is available on this link.

Rating action

Scope Ratings GmbH (Scope) has today affirmed the Land of Berlin’s (Berlin) long-term issuer and senior unsecured debt ratings at AAA in both local and foreign currency with a Stable Outlook. Scope has also affirmed the short-term issuer rating in local and foreign currency at S-1+ with a Stable Outlook.

Summary and Outlook

The AAA rating is underpinned by the highly integrated institutional framework under which Berlin operates, characterised by a very strong revenue equalisation system and the federal solidarity principle, which results in a close alignment of Länder’s creditworthiness with the German federal government’s AAA/Stable ratings. The rating also reflects Berlin’s conservative budgetary management, commitment to fiscal consolidation, favourable debt profile, excellent capital market access, prudent liquidity management and strong economic base. In addition, sizeable federal support measures have mitigated the adverse effects of the Covid-19 crisis and the Russia-Ukraine war on the economy and Berlin’s finances.

Credit challenges relate to high direct debt, low revenue flexibility given limited leeway to adjust revenue via own taxes, 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 were downgraded; and/or ii) changes affected the institutional framework, resulting in notably weaker support.

Rating rationale

Like all of Germany’s Länder, 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 and 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 AAA rating of the federal government.

The established German federal institutional framework, with a proven record of institutional support from the federal government and strong policy coordination, was able to tackle economic challenges and mitigate the pressure on sub-sovereign finances caused by the Covid-19 and Russia-Ukraine crises. The federal government has acted as a primary shock absorber by shouldering most of the costs of supporting businesses and households, as well as extending direct fiscal support to the federal states.

Second, Berlin’s AAA rating is supported by the Land’s conservative budgeting and accommodative financing conditions. This is underpinned by Berlin’s record of strong budgetary performance before the start of the Covid-19 pandemic in early 2020, with controlled expenditure growth and operating surpluses averaging a high 14% of operating revenue for the period 2012-19. As a result, Berlin posted eight successive annual surpluses after investment activities and interest payments averaging 2.6% of total revenues in the 2012-19 period, which supported a gradual reduction of its direct debt. Berlin’s improved budgetary flexibility is further supported by interest payments relative to operating revenues declining to around 3.1% in 2021, from 9.7% in 2012.

As was the case for the German federal government and other Länder, Berlin’s budgetary planning and fiscal outcomes were heavily impacted by the Covid-19 pandemic. Berlin’s senate reacted promptly to the shock and made the necessary adjustments to strengthen flexibility for the 2020/21 budget to counteract lower tax revenue and implement support measures for regional businesses and expand healthcare, testing and vaccination capacity.

Consequently, Berlin’s budget balance turned to a deficit (before debt movement) of EUR 1.4bn, or 4.6% of total revenues, in 2020 and 0.3% in 2021. At the same time, these results significantly outperformed Scope’s initial expectations and Berlin’s budgeted targets.

In 2021, a strong rebound in tax revenue resulted in a contained deficit of around EUR 120m, significantly outperforming an initially budgeted deficit of EUR 3.8bn and despite significant expenditure increases. Tax revenue stood at EUR 24.7bn, up 19% from 2020. Among a recovery of shared taxes, such as VAT and personal income tax, this was also due to pandemic-related one-off effects that shifted some corporate tax revenue from 2020 to 2021 and are thus unlikely to occur again in 2022/23. Total expenditure was up 8% in 2021 YoY, mostly due to higher staff and pension costs, transfers and other operating costs as well as pandemic-related expenditures, which however were partly funded by central government transfers.

Scope expects Berlin’s financial result to be in moderate deficit before debt movement of 1% on average over the 2022/23 period before returning to moderate surpluses of around 0.5% of total revenue thereafter. Berlin’s long-term consolidation strategy will be supported by conservative budgetary management, low financing costs, budgetary flexibility in view of high capital expenditure (10% of total expenditure on average from 2015-21) and accumulated budgetary reserves, and solid economic and demographic outlooks. At the same time, Berlin’s financial planning until 2025 re-balances personnel and other operating costs and re-prioritises investment activity. The plan also foresees the need for tight expenditure control in 2024/25 in view of high and rising spending and investment needs.

A third strength supporting Berlin’s AAA ratings is its excellent capital market access and prudent liquidity management. Berlin tapped the markets regularly during the ongoing Covid-19 crisis at favourable conditions, highlighting investor confidence. In addition, Berlin’s conservative debt-management strategy entails a long average maturity of issued debt (8.5 years at YE 2021), no new foreign currency risks (at YE 2021, 99.8% of total debt was denominated in euro) and limited interest rate risks (after swaps, 96.9% of debt was at fixed rate) with a declining use of interest rate swaps.

Berlin’s liquidity management is sound due to comprehensive inter-year cash planning and the availability of numerous sources of liquidity. Berlin increased its funding activity over 2020/21 in response to the pandemic, although not all funds raised were needed and thus placed into a budgetary reserve. Consequently, Berlin’s cash balance increased markedly over 2020/21. Access to liquidity for intraday needs, if required, is available through credit facilities from financial institutions. An additional source of liquidity is provided by commercial cash transactions between the Länder, which lend excess liquidity to each other. In combination with proven market access, the risk of liquidity shortages is negligible.

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 businesses, particularly in the dynamic information and communication sector. Berlin’s GDP per capita surpassed the German average in 2018 for the first time since 2000 and stood at 103.5% of the national average at YE 2021. Population growth has been strong with inhabitants increasing from 3.38m in 2012 to 3.67m in 2021, underpinned by annual net immigration of an average 28,000 from 2016-20. In 2022 the influx of refugees from Ukraine will lead to a sizeable increase of net immigration. As of 11 May 2022, around 45,000 Ukrainian refugees were registered for social security in Berlin. To compensate for some of the costs incurred by Berlin, it will receive EUR 110m in higher VAT revenues from the federal government.

Berlin’s economy was affected by the Covid-19 crisis in 2020, with real GDP declining by 3.8% versus 4.6% for Germany as a whole. Berlin’s relative economic resilience was strengthened by sectors that were adaptable to pandemic restrictions, such as its growing information and communication sector. Real GDP growth recovered to 3.3% in 2021, a slightly higher rate than for the German economy at 2.9%. Absent a sudden stop scenario of gas imports from Russia, Scope expects real growth of around 2.5% in Berlin, slightly higher than a 2.3% rate for Germany. Finally, Scope expects Berlin’s positive demographic trend to continue over the medium term, reflecting the metropolitan city’s attractiveness, which underpins a favourable economic outlook.

Despite these strengths, Berlin’s AAA rating faces 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 to EUR 63.7bn from EUR 57.6bn in 2019. In 2021, Berlin’s nominal debt stock increased further to EUR 65.9bn, above its previous peak in 2012. Debt relative to operating revenue amounted to 189% at YE 2021, down from 208% a year before, and still well below a peak of 289% in 2012. Scope expects debt to stabilise at its current level in nominal terms and trend down relative to operating revenue from an expected 190% this year to around 175% at YE 2025.

In response to the pandemic, Berlin’s parliament invoked the safeguard clause of the state’s debt brake law and implemented credit authorisations of EUR 7.3bn. The Land made use of the full envelope of authorisations to issue the corresponding amount of debt. Funds raised but not needed in 2020 of EUR 5.4bn were placed in a pandemic reserve earmarked for tax revenue shortfalls and pandemic-related expenditures. In 2021, largely due to significantly higher-than-expected tax revenue, the size of the pandemic reserve was broadly unchanged at EUR 5.4bn at YE 2021. Berlin plans to use funds remaining in the pandemic reserve until YE 2023. This would include an estimated EUR 810m for redemption of debt incurred under the pandemic credit authorisations, three times the foreseen annual instalments of EUR 270m until 2049.

Over the long term, Berlin faces high pension payments to its civil servants. Pension payments amounted to 8% of total expenditure in 2020, which was slightly 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, which were paused in 2020/21, resulting in largely unfunded pension commitments.

As for all German Länder, Berlin has little flexibility to adjust revenue and 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, weakening their link to the Land’s economic performance.

Finally, due to the extensive shareholdings of Berlin, an elevated level of contingent liabilities is a notable credit challenge. This exposure is mitigated by the low-risk aggregate profile of companies partially or wholly owned by Berlin. While the Covid-19 crisis has adversely affected the profitability of some of Berlin’s holdings – most notably the Berlin Brandenburg Airport of which Berlin holds 37% of equity - which required financial support from the Land in 2020 and 2021, the budgetary impact for Berlin is overall moderate. Scope views positively that almost all of the Land’s holdings are profitable and generally have low leverage. Most of Berlin’s holdings’ liabilities are incurred by low-risk entities such as the regional development bank Investitionsbank Berlin and social housing associations.

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 zero notches (high integration) and 10 notches (low integration).

The institutional and financial framework under which the German federal states operate displays high integration in: i) institutionalised support; ii) fiscal interlinkage; and iii) political alignment. Consequently, Scope’s assessment results in an indicative downward rating distance of up to one notch between the German sovereign (AAA/Stable) and the rating of an individual federal state.

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) budgetary performance and flexibility; iii) economy and social profile; and iv) quality of governance. This risk assessment is conducted on a scale of 1 to 100, with a high (low) score being associated with a strong (weak) credit profile.

Scope assesses Berlin’s individual credit profile as ‘medium’. The assessment is reflected by the outcome of the quantitative core variable scorecard and the qualitative assessment in the four respective categories defined above (individual credit profile score equal to 58 out of 100).

The results have been discussed and confirmed by a rating committee.

Factoring in of environment, social and governance (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 agency also considers long-term environmental developments that did not play a direct role in this rating action. Still, Scope notes policy objectives to achieve a reduction of CO₂ emissions by 70% relative to 1990 levels by 2030 and achieve climate neutrality (95% reduction) by 2045.

Rating committee
The main points discussed by the rating committee were: i) institutional framework; 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.

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sub-Sovereigns Rating Methodology, 5 May 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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.

Regulatory disclosures
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: Julian Zimmermann, Senior Analyst.
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Executive Director.
The Credit Ratings/Outlooks were first released by Scope Ratings on 14 July 2017. The Credit Ratings/Outlooks were last updated on 25 June 2021.

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.

Conditions of use / exclusion of liability
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