Scope Ratings GmbH (Scope) monitors and reviews its credit ratings on an ongoing basis and at least annually, or every six months in the case of sovereigns, sub-sovereigns and supranational organisations.

Scope performs monitoring reviews to determine whether material changes and/or changes in macroeconomic or financial market conditions could have an impact on the credit ratings. Scope considers all available and relevant information when undertaking the monitoring review.

Monitoring reviews are conducted by performing a peer comparison, benchmarking against the rating-change drivers, and/or reviewing the credit ratings’ performance over time, as deemed appropriate by the Lead Analyst or Analytical Team Head, in addition to an assessment of all aspects of the relevant methodology/ies, including key rating assumptions and model(s). Scope publicly announces the completion of each monitoring review on its website.

Scope completed the monitoring review for the Free State of Bavaria (long-term local- and foreign-currency issuer and senior unsecured debt ratings: AAA/Stable; short-term local- and foreign-currency issuer rating: S-1+/Stable) on 6 August 2024.

This monitoring note does not constitute a credit rating action, nor does it indicate the likelihood that Scope will conduct a credit rating action in the short term. Information about the latest credit rating action connected with this monitoring note along with the associated rating history can be found on www.scoperatings.com.

Key rating factors

The AAA/Stable rating reflects the following individual credit strengths: i) low debt burden and excellent capital market access; ii) ample liquidity and strong budgetary performance, and iii) a wealthy economy.

Bavaria benefits from a very low debt burden. In 2023, debt to operating revenue amounted to 25%, the lowest among all German Länder. With the start of the pandemic, the ratio increased to 29% in 2020 from 21% in 2019. Scope expects debt to operating revenue to continue on its downward path as pandemic related debt is repaid. As for all German Länder, Bavaria’s capital market access is excellent as underlined during the Covid-19 pandemic when Bavaria re-entered the bond market for the first time since 2014 in 2020, issuing EUR 7.2bn mostly at near-zero coupons. In 2022 and 2023, Bavaria did not tap public debt markets, indicating limited financing needs and reflecting volatile public capital markets as the ECB tightened monetary policy.

Bavaria’s AAA rating is further underpinned by its sizeable cash reserves, which is higher than that of other Länder, stemming from its sound budgetary and financial management. Bavaria’s cash holdings comfortably cover debt service through to 2028. Access to external liquidity, if required, is available at short notice via credit facilities from major financial institutions. German Länder lend excess liquidity to each other via cash transactions, generating another source of liquidity. Combined with Bavaria’s own sizeable reserves, this makes the risk of a liquidity shortfall negligible.

Moreover, Bavaria benefits from a wealthy, well-diversified and highly competitive economy, which constituted almost 19% of German GDP in 2023 and is the second-largest contributor after North Rhine Westphalia. This results in a high regional growth potential and a strong ability to consistently generate its own revenues. The state is one of the wealthiest regions in Europe, with a GDP per capita of 18% above the German average, and the largest contributor to the federal equalisation system.

In addition, the rating is underpinned by the highly integrated institutional framework under which all German federal states, or Länder, operate, characterised by a very strong revenue equalisation system together with the federal solidarity principle and the primary shock-absorbing role the federal government has assumed in the context of the Covid-19 and Ukraine-Russia crises which enable the Land to better counteract the resulting economic and financial shocks.

Credit challenges relate to i) limited revenue flexibility, ii) high pension liabilities that weigh on long-term expenditure flexibility, and iii) sizeable, although largely low-risk, contingent liabilities.

Bavaria mainly receives shared taxes like all Länder (largely personal income taxes, VAT taxes and corporate taxes) and a substantial share of taxes is subject to federal revenue equalisation. This limits revenue flexibility and weakens the link between tax revenue and the state’s economic performance. Tax estimates published in May put tax revenues below budgeted levels, especially in 2024 (EUR 640m below budget) and 2025 (EUR 466m below budget). While the 2024/25 budget had sufficient headroom to absorb the lower tax estimates, budgetary pressures remain elevated. The results of the 2022 census announced in June 2024 re-estimated population figures which are a key input for the federal revenue equalisation. In connection with the distribution of the sales tax among the German Länder, this is likely to lead to lower funds allocated to Bavaria of around EUR 291m per year from 2024 (or around 0.4% of operating revenues).

Expenditure flexibility is generally limited with personnel costs representing around 45% of operating revenue in 2023. These pressures are only exacerbated by the latest collective wage agreement, which is also applied to the Land’s civil servants. Additional spending pressure is expected following the floods in June 2024. The government launched a comprehensive emergency assistance package and increased the level of available funds to up to EUR 200m of which EUR 20.9m had been paid out as of 8 July 2024. However, rising expenditures are mitigated by strong budgetary management and commitment to the debt brake. The Land does not plan to take on new net debt and has budgeted repayments of EUR 50m annually in 2024 and 2025.

Sizeable pension liabilities represent a further challenge for the Land placing structural pressure on expenditure flexibility. To ease rising pressure from an ageing population (average age of the population in Bavaria is with 43.7 years slightly below the national average of 44.3 years), Bavaria has created a pension fund which was endowed with EUR 4.01bn by the end of 2023. Until 2030, annual contributions of at least EUR 110m are planned.

Finally, challenges also relate to Bavaria’s sizeable though low-risk contingent liabilities, mainly due to its 75% shareholding in the BayernLB bank. However, financial risks stemming from the state’s exposure declined after BayernLB repaid its state aid in 2017 and the bank maintains a strong financial position.

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; ii) changes to the institutional framework were to result in a notably weaker individual credit profile; and/or iii) the individual credit profile deteriorated significantly and structurally.

The methodology applicable for the reviewed ratings and/or rating Outlooks (Sub-Sovereigns Rating Methodology, 11 October 2023) is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
This monitoring note is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
Lead analyst Eiko Sievert, Senior Director

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