Rating action

Scope Ratings GmbH (Scope) has today affirmed the Land of Saxony-Anhalt’s (Saxony-Anhalt) local- and foreign-currency long-term issuer and senior unsecured debt ratings at AAA. Scope has also affirmed the local- and foreign currency short-term issuer ratings at S-1+. All Outlooks are Stable.

The associated rating report is available here.

Summary and Outlook

The AAA rating is underpinned by the highly integrated institutional framework under which all German federal sates, or Länder, operate, 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.

Saxony-Anhalt’s AAA rating is further underpinned by the following individual credit strengths: i) sound budgetary management, with operating performance benefitting from sizeable and predictable intergovernmental transfers; ii) strong debt and liquidity management, including via a commercial paper programme, which enhances its short-term financing flexibility, assured access to external liquidity, and excellent capital market access and funding conditions; and iii) low contingent liability risks.

Challenges are: i) a high debt level; ii) limited revenue flexibility and moderate expenditure flexibility coupled with rising spending pressures; and iii) a relatively modest socio-economic profile vis-à-vis peers.

The Stable Outlook represents Scope’s view that risks to the ratings over the next 12 to 18 months are balanced.

The ratings/Outlooks could be downgraded if: i) the German sovereign rating/Outlook were downgraded; ii) changes affected the institutional framework, resulting in notably weaker support; and/or iii) the individual credit profile deteriorated significantly and structurally.

Rating rationale

First, Saxony-Anhalt benefits from the mature and highly integrated German federal institutional framework. The strong integration in the co-operative federal system closely links the credit ratings of the German Länder with the AAA rating of the federal government. 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.

A further key element of the institutional framework is the constitutional debt brake, limiting structural deficits at the federal level to 0.35% of GDP and 0% for the Länder. In response to the Covid-19 and energy crises, the German federal parliament used the emergency clause of the debt brake in 2020-2023, along with the Länder governments separately invoking the safeguard clauses of their respective debt brake laws during the crises. An important, recent development is the federal constitutional court’s ruling from 15 November 2023 on the Second Supplementary Budget Act 2021 of the federal government, which was deemed unconstitutional and thus void. Crucially, the ruling also gives the constitutional court’s broader interpretation of emergency budgetary practices under debt brake rules widely implemented by the federal and state governments since 2020. The ruling has implications for the Länder, as they employed similar budgetary practices of using emergency credit authorisations in a given year for budgetary reserves for spending in subsequent years.

Saxony-Anhalt was also affected by the ruling as it had set up a Covid-19 special fund of EUR 2bn in 2021, targeted at enhancing the state’s long-term social resilience. The fund’s spending between 2022 and 2027 was initially planned to be funded via a reserve filled with funds raised via emergency credit authorisations in 2021. To ensure the legal basis of its special fund in light of the constitutional court ruling, Saxony-Anhalt passed a supplementary budget for 2023 and ensured its budgetary act for 2024 is in line with requirements. This budgetary response will not lead to higher borrowing, as the special fund’s aggregate envelope remains unchanged at EUR 2bn. Both budget laws include annual emergency credit authorisations for spending under its Covid-19 special fund. The existing reserve of unspent funds raised in 2021 for the special fund will be unwound in 2024.

Overall, 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 energy crises. The federal government confirmed its role as a primary countercyclical shock absorber during these crises in 2020-2023, shouldering a large part of the costs to the economy, leading to federal budget deficits averaging 3.3% of GDP over 2020-2022.

Second, Saxony-Anhalt’s AAA rating is supported by the Land’s sound budgetary performance, with its revenues underpinned by a high share of stable and predictable intergovernmental transfers.

Saxony-Anhalt displayed solid budgetary performance between 2016 and 2019, with operating margins of an average 12% of operating revenue. Operating surpluses supported the Land’s ability to cover interest payments and capital expenditure without the need for additional borrowing. As a result, the surplus after capital accounts averaged 2% of total revenue between 2016-2019.

From 2020, the Covid-19 shock heavily impacted budgetary planning and fiscal outcomes. The Land’s budget balance turned to a deficit (before debt movement) of 7.9% of total revenue in 2020 and 1.4% in 2021. In 2022, the state posted strong results, ending the year with a EUR 560m surplus before debt movement, or 4.1% of total revenue. The better-than-expected result in 2022 allowed the state to redeem emergency borrowings and net borrowing incurred under the cyclical component of its debt brake, and to allocate funds to its budgetary reserve. Financial performance benefitted from very strong nominal tax revenue.

For 2023, Scope expects a moderate deficit before debt movement of around 0.5% of total revenue. Tax revenues are expected to be broadly in line with budgeted levels at around EUR 8.8bn, while operating expenditure should grow by 5%, which would lead to a deterioration in the operating margin to 9.3% of operating revenue, from 14.1% in 2022. In addition, moderately higher interest expenses and elevated capital expenditure are expected to lead to the projected deficit.

For the years 2024 to 2026, Scope expects continued deficits after capital accounts of an average 1.8% of total revenue due to multiple budgetary headwinds. While budgetary performance will benefit from tax revenue growth of an average 3.4% per year, high operating and investment spending will more than offset increased tax revenue. Spending pressures arise from higher spending on personnel, not least due to the increase in salaries of employees agreed in December 2023 and corresponding pay rise for civil servants, higher operating transfers to municipalities and high planned capital expenditure, partly also due to the investment needs in coming years linked to Intel’s planned chip manufacturing plant in the state.

In light of these budgetary pressures, the Land’s financial planning will need to enforce tight expenditure control, also given that budgetary reserves will likely be depleted in the near term. Overall, the state’s commitment to fiscal consolidation, conservative budget management and low debt service costs will help mitigate budgetary risks and enable the state to follow its long-term fiscal consolidation strategy.

A third strength supporting the AAA ratings is the state’s strong debt and liquidity management, including via a commercial paper programme, assured access to external liquidity, and excellent capital market access and funding conditions.

Saxony-Anhalt’s proactive debt management limits maturity, foreign-currency and interest-rate risks, while securing favourable funding conditions and lower net interest payments for the state. The average maturity of capital market debt is 8.9 years. Saxony-Anhalt maintains a market presence in the USD and GBP markets, although the main funding currency is the euro with around 97% of debt outstanding denominated in EUR. Saxony-Anhalt employs derivatives to hedge its foreign-currency and interest-rate risk, such that after hedging, exposure to these risks is minimal. Overall, the need for hedging reduced in recent years due to the Land’s higher issuance of EUR-denominated, fixed-rate benchmark bonds. Further, the Land broadened its capital market presence by issuing its first social bond of EUR 500m in 2023, with proceeds of the issue funding the Land’s Covid-19 special fund and therefore its longer-term social resilience. Scope views the social bond issuance as credit positive, as it widened the Land’s investor base.

Saxony-Anhalt’s interest payments are low given its proactive debt management and the safe-haven status of the German Länder. The implicit cost of outstanding debt was 1.2% in 2022. Interest payments declined to 2.1% of operating revenue in 2022, from 5% in 2016, raising financial flexibility. The Land’s interest payments are expected to increase in 2023 and coming years due to the overall tightening of financing conditions in the euro area, but to remain moderate and below 3% of operating revenue.

The state’s liquidity management is sound due to comprehensive inter-year cash planning and the availability of numerous sources of liquidity, as well as available cash buffers. Between January and September 2023, the Land’s average cash balance stood at around EUR 2bn. A unique feature among German Länder is Saxony-Anhalt’s commercial paper programme with an envelope of EUR 2bn, raising its short-term financing flexibility. Additional continued access to liquidity to bridge intraday needs, if required, is available through credit facilities from major financial institutions. An additional source of liquidity is also provided by commercial cash transactions between the German Länder, which lend excess liquidity to each other. As a consequence, the risk of liquidity shortages is negligible.

Finally, Saxony-Anhalt’s credit profile benefits from relatively low contingent liability risks vis-à-vis other German Länder.

This is driven by the low level and low-risk nature of contractual guarantees, limited contingency risk stemming from its shareholdings, and a relatively smaller unfunded pension liability compared to peers and the Land’s conservative and forward-looking management of its pension fund.

First, contractual guarantees stood at EUR 3.0bn in 2022 (23% of operating revenue), up from EUR 2.8bn in 2021. At YE 2022, only around EUR 1.7bn of these guarantees were utilised. There is a limited risk that the obligations of entities and projects guaranteed by Saxony-Anhalt will crystallise onto the Land’s balance sheet. Around EUR 1.9bn, or two thirds of total contractual guarantees, are related to the wholly-owned development bank Investitionsbank Sachsen-Anhalt. In line with other German development banks, the risk stemming from the guarantee is very low, as the bank has ample capitalisation and liquidity, and runs a low-risk, development-oriented business model. Another 9% of guarantees are towards KfW (AAA/Stable), the federal development bank.

Second, contingency risks stemming from Saxony-Anhalt’s shareholdings are low. The state had a total of 58 shareholdings with direct ownership shares at YE 2022, 20 of which are majority-owned. The most notable shareholdings are the wholly-owned Investitionsbank Sachsen-Anhalt, a 6%-stake in NordLB and two university hospitals (Magdeburg and Halle (Saale)).

Finally, and in line with other Länder, Saxony-Anhalt has unfunded pension liabilities due to pensions related to its civil servants which need to be paid out of regular future budgets. However, the risk related to these obligations is relatively lower than for most other states due to Saxony-Anhalt’s conservative management via its pension fund, with assets worth EUR 1.9bn as of September 2023. The fund covers a relatively larger share of pension liabilities than for other states and receives EUR 300m in annual transfers to ensure a 100% coverage for civil servants that entered after 2007, and at least partial coverage for civil servants that entered before 2007. The pension fund will allow the Land to smooth pension payment peaks.

Despite these strengths, Saxony-Anhalt’s AAA rating faces several challenges.

First, Saxony-Anhalt’s debt is high compared to peers. The Land’s debt of around EUR 23bn amounted to 180% of operating revenue at YE 2022. This is the fourth-highest ratio among the Länder, and well-above the sector-wide average of 120% in 2022. In coming years, the debt to operating revenue ratio should decline gradually to around 171% by 2026, as nominal debt should rise only moderately and operating revenue is expected to grow at an annual rate of 2.6% over 2024-2026.

For 2023, Scope expects the Land’s debt burden to remain broadly stable, while existing budgetary reserves will likely be used to lower the need for net borrowing. Over the projection horizon to 2026, Scope projects the debt burden to increase moderately in nominal terms, from an expected EUR 23.0bn in 2023 to around EUR 23.6bn at YE 2026. Due to rising operating revenue, the debt to operating revenue ratio is projected to decline by around 9pps to 171% in 2026.

Risks associated with the relatively high debt stock are mitigated by conservative debt management and a low-risk debt profile. Debt service amounts to around EUR 2.0-2.5bn per year, or 10-15% of the outstanding debt stock, and has been declining in recent years in line with falling interest payments and a long average maturity of debt.

Second, Saxony-Anhalt’s overall budgetary flexibility is relatively limited, in line with other German Länder.

Saxony-Anhalt’s flexibility to adjust expenditure is moderate, since minimum legislative requirements and the socially sensitive nature of several expenditure items make most items difficult to trim. At the same time, Saxony-Anhalt’s above-average flexibility benefits from a high share of investment relative to total expenditure at an average 12.5% between 2018 and 2022, as well as a relatively lower share of personnel spending of around 27% of operating expenditure (including 4.2% of operating expenditure in pension spending, which is lower than the Länder average, a common feature among Eastern German states).

Saxony-Anhalt’s revenue flexibility is very limited, as almost the entirety of operating revenue stems from shared taxes and intergovernmental transfers. In line with constitutional arrangements, the Länder receive shared taxes, largely revenues from personal income taxes, VAT and corporate taxes. These revenues are initially collected by regional tax offices but are later redistributed at a national level in accordance with revenue-sharing agreements and additional transfer mechanisms.

A final credit challenge is the Land’s relatively modest socio-economic profile vis-à-vis peers.

Saxony-Anhalt exhibits a relatively lower GDP per capita than the German average, a small economic size with a contribution to national GDP of around 2%, a higher unemployment rate and lower growth potential than peers, mostly driven by adverse demographic trends. However, the federal equalisation system delinks to a large extent regional economic and tax revenue performance.

At the same time, Scope notes several positive trends, such as the planned construction of a chip manufacturing plant by Intel near Magdeburg, which will boost regional output and employment. Second, wealth levels are converging to the German average, with GDP per capita standing at EUR 34,505 in 2022, or 75.3% of the national average, up from 70% in 2012. This was particularly supported by real GDP growth rates overperforming in 2020-2022 on average. Finally, net migration into Saxony-Anhalt from other Länder has been positive since 2014, reversing a former trend of negative net migration.

In the medium term, Scope projects Saxony-Anhalt to grow at a slower pace than Germany, which is mostly driven by adverse demographics. The state’s workforce has shrunk for years, with a drop in its working-age population (persons aged 15-66) of around 200,000 persons, or 12.6% between 2010 and 2022. In the years to 2030, official population projections estimate the working-age population to shrink further by an annual 1.2% on average. This contributes negatively to potential growth, which Scope estimates at an average 0.2% for Saxony-Anhalt until 2030, against 0.7% for Germany as a whole.

Institutional framework assessment

Scope’s institutional framework assessment determines the intergovernmental integration between sub-sovereigns and their rating anchor, which is the sovereign or a higher-tier government. To perform this assessment, Scope applies the Institutional Framework scorecard (QS1), centred on six analytical components: i) extraordinary support and bailout practices; ii) ordinary budgetary support and fiscal equalisation; iii) funding practices; iv) fiscal rules and oversight; v) revenue and spending powers; and vi) political coherence and multilevel governance.

Scope considers the institutional framework under which the German Länder operate to display ‘full’ integration for: i) extraordinary support and bailout practices; ii) ordinary budgetary support and fiscal equalisation; iii) fiscal rules and oversight; iv) revenue and spending powers; and v) political coherence and multilevel governance. The institutional framework displays ‘medium’ integration for funding practices. 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 state.

Individual credit profile

Scope assesses the individual credit profile based on quantitative and qualitative analysis of four risk categories: i) debt and liquidity; ii) budget; iii) economy; and iv) governance. These are further complemented by additional adjustments for environmental and social factors & resilience.

The outcome of these assessments, as reflected in the application of the Individual Credit Profile scorecard (QS2), is an individual credit profile score for Saxony-Anhalt of 45 out of 100.

The mapping of this score to the range defined by the Institutional Framework assessment results in an indicative rating for Saxony-Anhalt aligned with the sovereign rating, corresponding to an AAA indicative rating.

The review of potential exceptional circumstances that cannot be captured by the Institutional Framework and Individual Credit Profile scorecards did not lead to further adjustments to Saxony-Anhalt’s indicative rating. As such, the final rating corresponds to the indicative rating of AAA.

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

Factoring of Environment, Social and Governance (ESG)

ESG factors material to Saxony-Anhalt’s credit quality are captured by Scope’s rating approach through several analytical areas.

Scope’s assessment of Germany’s sovereign credit quality includes an appraisal of ESG risks, as detailed in Scope’s Sovereign Rating Methodology.

Governance considerations are material to Saxony-Anhalt’s rating and are included in Scope’s institutional framework assessment and its assessment of the Land’s individual credit profile. These highlight the high quality of governance alongside the administration’s record of sound liquidity and debt management practices, in line with other sector peers.

The institutional framework assessments capture governance factors under fiscal rules and oversight, assessed as ‘full integration’ for the German Länder. This reflects the comprehensive and credible fiscal framework in the form of the debt brake, as well as the strong oversight role of the Stability Council. Governance factors are also captured under political coherence and multilevel governance, assessed as ‘full integration’, reflecting Germany’s predictable and supportive federal system, where any major reforms are discussed and agreed upon well in advance and in consultation with the Länder.

The individual credit profile captures governance factors under the ‘quality of governance and financial management’, where Saxony-Anhalt is assessed as ‘stronger’, reflecting its: i) track record of fiscal consolidation and credible commitment to fiscal sustainability; ii) strong debt and liquidity management and regular and extensive reporting; iii) management of contingent liability risks related to unfunded pension liabilities via its pension fund and regular annual transfers to the fund to ensure long-term sustainability; and iv) ability to formulate and implement long-term economic and fiscal strategies.

Social considerations are included in Scope’s assessment of Saxony-Anhalt’s ‘economic sustainability’. The main social risk for the state is its shrinking and ageing society, which weighs on the state’s economic growth potential and business dynamism.

Additional environmental and social factors can be material for sub-sovereign creditworthiness beyond what is already captured in other sections of the methodology. In the case of Saxony-Anhalt, no additional adjustments to the individual credit profile apply for social and environmental factors & resilience beyond what is already reflected under other risk pillars.

Scope notes policy objectives to reduce regional annual greenhouse gas emissions by 5.65m tonnes of CO2 equivalents between 2021 and 2026, and by 10m tonnes by 2030 (emissions were around 31m tonnes of CO2 equivalents in 2021). The state also targets climate neutrality in line with the nationwide goal by 2045. Further, the share of renewable energy is to be increased, to 100% of gross electricity consumption by 2030, from 76% in 2021, and to 45% of primary energy consumption, from 26% in 2021.

Saxony-Anhalt is exposed to both physical and transition environmental risks, which are however materially mitigated by the federal solidarity principle. A prominent risk relates to flooding, as highlighted by heavy rainfall and flooding catastrophes in 2002 and 2013. Also more recently, heavy rainfall led to flooding in some areas in Saxony-Anhalt since late December 2023. In response to past crises, the Land’s flooding protection has been steadily improved, enhancing future resilience. After the 2013 flooding, the central and state governments set-up and co-financed a recovery fund of EUR 8bn, highlighting the federal solidarity principle.

Saxony-Anhalt is exposed to transition risks over coming years on its path to climate neutrality by 2045. As a lignite coal region, the region is gradually exiting coal production and closing down coal energy plants, with a full exit by 2038. The central government is supporting the region’s coal exit via significant grants in support of the economic transition.

The main social risk factor is the region’s shrinking population, which has direct budgetary consequences via the state’s allocation from the federal financial equalisation mechanism, which is linked to population figures.

Rating Committee
The main points discussed by the rating committee were: i) institutional framework; ii) debt burden, liquidity profile and contingent liabilities; iii) debt management strategy; iv) budgetary performance and flexibility; v) regional socio-economic and demographic developments; vi) peer comparison; and vii) environmental and social factors.

Methodology
The methodology used for these Credit Ratings and/or Outlooks (Sub-sovereigns Rating Methodology, 11 October 2023) 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: public domain, the Rated Entity.
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 Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings and Outlooks 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: Julian Zimmermann, Associate Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 26 October 2018.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Saxony-Anhalt 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 "Publication Calendar 2024 Sovereign, Sub-Sovereign and Supranational Ratings" published on 15 December 2023 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 publication of the ratings.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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