Rating action

Scope Ratings GmbH (Scope) has today affirmed the Land of Berlin’s (Berlin) 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.

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Key rating drivers

The closely-integrated German federal framework results in a close alignment of Länder’s ratings with the Bund’s AAA/Stable rating. Key elements of the framework include: 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 budgetary emergencies.

A further key element of the institutional framework is the constitutional debt brake, which limits structural deficits. Budgetary practices under the debt brake rule were impacted by the federal constitutional court’s ruling from 15 November 2023 on the Second Supplementary Budget Act 2021 of the federal government. The ruling effectively limits the budgetary practice of using emergency credit authorisations to create budgetary reserves for future spending, which was also commonly used by Länder governments since 2020, thus also impacting their budgetary practices. The ruling also affected Berlin’s budgetary strategy, with the Land cancelling its plans for a debt-funded EUR 5bn climate special fund.

Berlin’s ‘mid-range’ individual credit profile with the following credit strengths: i) conservative budgetary management and a track record of fiscal consolidation; ii) excellent capital market access and a favourable debt profile; iii) prudent liquidity management; and iv) a strong socio-economic profile.

Track record of fiscal consolidation and conservative budgetary management. This has been underpinned by controlled expenditure growth between 2012 and 2019, with high operating surpluses averaging 14% of operating revenue and growth in operating expenditure matching that for operating revenue over the same period. High operating surpluses allowed Berlin to post surpluses after investments, averaging 2.6% of total revenue between 2012-19, to build up budgetary reserves and to maintain a gradual reduction in its debt burden.

In 2020/21, Berlin’s budgetary planning and fiscal outcomes were impacted by the Covid-19 pandemic, in line with other Länder. Lower-than-budgeted tax revenue, and additional expenditures, led to a reduction in the operating balance to an average 5.9% of operating revenue and overall deficits of an average 2.5% of total revenue. In 2022, Berlin posted a surplus of 2.0% of total revenue, having benefitted from strong nominal tax revenue. Combined with reserves maintained during the pandemic, this allowed the Land to enter 2023 with significant budgetary reserves, which will help absorb expected deficits for 2023-25.

Berlin’s budgetary flexibility is supported by interest payments relative to operating revenues declining to 2.1% in 2023, from 9.7% in 2012. Scope expects the net interest burden of the Land, which also benefits from high rates for invested term deposits, to gradually rise, but to remain well below levels observed ten years ago.

Excellent capital market access, favourable debt profile and prudent liquidity management. Berlin enjoys excellent capital market access and funding conditions, as one of the larger debt issuers in the European sub-sovereign debt capital markets. The Land’s debt profile is low-risk, with minimal shares of FX-denominated debt and of variable-rate interest rates after hedging, and a long average maturity of around eight years. In 2023, the Land issued its first sustainable bond, broadening its investor base.

Scope regards Berlin’s liquidity management, cash reserves, and access to external liquidity as excellent, consistent with general practices among the German Länder. Additional liquidity to bridge intraday needs, if required, is available through credit facilities from major financial institutions, and commercial cash transactions between the German Länder provide an additional liquidity source. Thus, the risk of liquidity shortages is negligible.

A strong economic base and favourable demographics. Berlin benefits from a robust socio-economic profile underpinned by strong growth dynamics, favourable demographics and vibrant start-up and IT sectors. The Land’s regional economy remained resilient through the Covid and energy crises, with real GDP at the end of 2023 around 7% above its 2019-level, compared to less than 1% for Germany as a whole.

Berlin’s GDP per capita surpassed the German average in 2018 for the first time since 2000 and stood at 105% of the national average in 2023. This trend is expected to continue, with projected annual working-age population growth of 0.35% until 2030, contributing to the state’s growth potential. Berlin, with around 3.7m inhabitants, is the country’s largest city and has been attracting an average of 31,000 inhabitants annually from 2016 to 2022 due to its attractiveness and net immigration from other European and non-European countries.

Rating challenges are: i) high debt levels, ii) rising budget pressures with moderate budgetary flexibility, and iii) sizeable though largely low-risk contingent liabilities, including unfunded pension commitments.

Berlin’s debt is high compared to peers, but associated risks are mitigated by a favourable debt profile and excellent market access. Further, the authorities’ commitment to fiscal consolidation and the debt brake support a broadly stable debt trend.

Following successful budget consolidation leading up to the Covid-19 shock and a reduction in debt levels to EUR 57.6bn at YE 2019, debt increased to EUR 65.9bn in 2021/22 due to crisis-related borrowing. In response to the pandemic and in line with other Länder and the federal government, Berlin’s parliament invoked the safeguard clause of the state’s debt brake law and implemented credit authorisations of EUR 7.3bn in 2020. The Land made use of the full envelope of authorisations to issue the corresponding amount of debt. In 2023, nominal debt declined to EUR 64.2bn. Relative to operating revenue, debt amounted to 185% at YE 2023, slightly up from 180% a year earlier due to lower operating revenue, but still below a peak of 289% in 2012.

In the coming years, Scope expects nominal debt to rise moderately, and to decline very gradually as a share of operating revenue to around 184% at YE 2025. The government cancelled its plan to set up a multi-year, debt-funded special fund worth EUR 5bn for climate transition projects, due to doubts it would meet the requirements under the state’s debt brake. The Land currently plans with net borrowing of around EUR 1.7bn for 2024 and EUR 440m in 2025.

Budgetary pressures with moderate budgetary flexibility, necessitating consolidation efforts by the Land.

Spending pressures stem from personnel expenditure, transfers to its districts, refugee-related expenses, and net interest expenditure. Capital expenditure is expected to remain high, due to government investment priorities in schooling, social housing and decarbonisation. At the same time, robust tax receipts underpin the state’s revenue base, although growth is expected to be less dynamic than that for expenditures. The use of flexibilities of the debt brake to increase borrowing, for example for spending on financial transactions, will help to create some leeway, but consolidation programmes remain essential. Near-term, Berlin will make use of reserves to manage various budgetary risks, but these are expected to be depleted by YE 2025.

Scope expects deficits before debt movement of an average 9% of total revenue for 2024/25, which will be partly debt-financed. Structurally higher spending will require Berlin to re-balance spending and investment activity. Tight expenditure control will be necessary given high spending and investment needs. Over the medium term, Scope expects Berlin to adhere to its long-term fiscal strategy, supported by a commitment to fiscal consolidation, conservative budget management, still-low debt service costs, and the Land’s economic and demographic outperformance compared to national peers.

As for all German Länder, Berlin’s revenue flexibility is generally limited, as a large share of operating revenue stems from shared taxes. Additionally, expenditure flexibility is also generally low, due to spending items such as personnel costs making up a large share of operating expenditures (34% in 2023). At the same time, Berlin retains a relatively high share of investment spending, representing a more flexible spending category.

Finally, Berlin is exposed to some contingent liability risks, although the overall impact on its individual credit profile is low. Main contingent liabilities stem from: i) contractual guarantees mostly for utilities, housing, and the airport, ii) strategic shareholdings, and iii) largely unfunded pension liabilities.

Berlin has a moderate level of contractual guarantees outstanding. As of 2023, outstanding guarantees stood at EUR 4.1bn. There is a limited risk that the obligations of entities and projects guaranteed by Berlin will crystallise onto the Land’s balance sheet.

Berlin’s shareholdings play a critical role in the state’s investment policy. The roughly 40 majority-owned companies fulfil a significant public-sector mandate for Berlin by helping to boost the city’s regional economy. The overall exposure to contingent liabilities is mitigated by the low-risk aggregate profile of companies partially or wholly owned by Berlin. Almost all of the Land’s holdings are profitable and generally have low leverage. In 2023, Berlin-Brandenburg airport (Berlin holds a 37%-stake) and the wholly-owned hospital operator Vivantes posted losses. The Land continues to support both entities, for example via a final tranche of capital planned for the airport in 2026 on the entity’s path to self-sustainability, but overall budget impact from these support measures is modest.

Finally, and in line with other Länder, Berlin faces significant, unfunded pension commitments for its civil servants, which are financed via the state’s regular budget. The fund’s assets amounted to around EUR 1.4bn at YE 2023, compared to a net present value of EUR 70bn in future obligations over the next 30 years, according to an external actuary. This results in largely unfunded pension commitments. The pension fund is not designed to cover all future liabilities but serves as a buffer to address peaks for pension payments, with withdrawals from the fund permitted starting from 2031.

Outlook and rating sensitivities

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

Downside scenarios for the rating and Outlooks are (individually or collectively):

1. Downgrade of Germany’s sovereign rating/Outlook;
    
2. Changes in the institutional framework resulting in notably weaker support;
    
3. The individual credit profile weakened significantly and structurally.

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 Berlin of 50 out of 100.

The mapping of this score to the range defined by the Institutional Framework assessment results in an indicative rating for Berlin 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. As such, the final rating corresponds to the indicative rating of AAA.

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

Environmental, social and governance (ESG) factors

ESG factors material to Berlin’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 Berlin’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 Berlin is assessed as ‘stronger’, reflecting its i) track record of nominal debt reduction and build-up of budgetary reserves before the Covid-19 pandemic and a commitment to return to structurally balanced budgets; ii) regular fulfilment of policy objectives defined in strategic plans; and iii) ability to adjust expenditure to compensate for adverse budgetary developments.

Social considerations are included in Scope’s assessment of Berlin’s ‘economy and social profile’, highlighting a healthy labour market and favourable demographics, but also the need to support its citizens in the context of rising pressures on housing affordability. Examples of the Land’s policies to support affordable housing during the recent cost-of-living crisis include a moratorium for its housing associations to evict tenants based on late payments, as well as freezing rent levels until the end of 2023 for the Land’s housing associations.

Alongside the assessment of rating-relevant credit risks, Scope also considers long-term environmental developments that did not play a direct role in this rating action. Scope notes policy objectives to achieve a reduction of CO2 emissions by 70% relative to 1990 levels by 2030, by 90% by 2040, and to achieve climate neutrality by 2045. To achieve this, the Land is i) utilising an internal CO2 price of EUR 195 per tonne, ii) renovating its own housing stock for more energy efficiency, and iii) building charging infrastructure for electric vehicles across the city, among other measures. Further, the phaseout of energy generation from coal has been set for 2030. In May 2024, Berlin acquired 100% of the BEW Berliner Energie und Wärme AG, a district heating provider. With the acquisition, the Land paves the way for increasingly using sustainable sources of energy in district heating.

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 Berlin, no additional adjustments to the individual credit profile apply for social and environmental factors and resilience.

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/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings and/or Outlooks 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, Associate Director
Person responsible for approval of the Credit Ratings: Jakob Suwalski, Senior Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 14 July 2017. The Credit Ratings/Outlooks were last updated on 2 June 2023.

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, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
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