Very supportive institutional framework, commitment to fiscal consolidation, downward debt trajectory and strong liquidity management support the rating. High legacy debt, limited financial flexibility and contingent liabilities remain challenges.
Scope Ratings GmbH 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.
The AAA rating reflects the strong support for Berlin from the German institutional framework, a clear commitment to fiscal consolidation, the firm downward trajectory and favourable profile of the Land’s direct debt, as well as strong liquidity management. Challenges to the rating include legacy debt levels that remain high and limited fiscal flexibility which is mitigated in part by a growing proportion of more flexible capital expenditures. The Land of Berlin’s contingent liabilities are sizeable, but Scope believes they pose low risks to its balance sheet. The Stable Outlook reflects Scope’s assessment that risks for the Land of Berlin remain balanced.
The Land of Berlin’s AAA rating is bolstered by a very supportive German institutional system with a very strong revenue equalisation mechanism, a legally tested extraordinary support mechanism, a safe and predictable cash management system designed to guarantee efficiency and liquidity at any point in time, and access to deep capital markets. It is Scope’s view that these factors align the credit profiles of the Länder and the federal government (the Bund, AAA, Stable Outlook).
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Following significant consolidation efforts, Berlin’s budgetary performance has improved substantially on past years of successive deficits. High operating surpluses averaging 14.2% of operating revenues from 2012-2017 (above the Länder average of 12.3%) enhanced Berlin’s ability not only to fund its operating expenses with operating revenue but also to realise extra revenue to cover interest payments and some capital expenditure. The Land’s balance before debt movement has remained in positive territory since 2012, supporting a gradual reduction of Berlin’s debt burden. In 2017, Berlin continued to demonstrate its fiscal commitment, also benefitting from sustained and strong tax revenue growth as well as greater fiscal room thanks to its solid track record of fiscal consolidation. Under the conservative medium-term financial plan for 2018-2021, Scope expects operating surpluses to decline slightly but to average 12.3% of operating revenues due to rising operating expenses and investments needed to address the city’s rapid growth and migration flows. Over the medium term, Scope expects the Land to maintain its prudent budgetary policy and adhere to its consolidation strategy.
Scope views the Land of Berlin’s liquidity management as sound. The key elements of this management are comprehensive inter-year cash planning and the availability of numerous sources of liquidity, reflecting sophisticated state treasury and liquidity management. Additional continued access to liquidity to bridge intraday needs, if required, is available through credit facilities from major financial institutions. Further liquidity is also available from cash transactions between the German Länder, which place excess liquidity with each other, effectively acting as lenders, as well as mutual agreements between the Länder and the Bund in case of need during periods of stress.
The Land of Berlin has a solid track record regarding access to capital markets. During the last financial crisis, access remained excellent, reflecting investor confidence in the German solidarity system. At the end of 2017, Berlin lengthened its weighted debt maturity to 7.6 years, up from 7.1 years at the end of 2016. Scope views the Land’s debt profile as favourable, with debt reductions in combination with excellent market access resulting in a low average cost of outstanding debt of 1.8% in 2017. Lower net interest payments have halved the burden on the budget to 4.9% of operating revenues in 2017, down from 9.6% in 2012.
Berlin benefits from favourable economic and demographic trends. In 2017, Berlin’s GDP expanded by 3.1%, outperforming the German average of 2.2%. Should growth continue to exceed the German average, the GDP-per-capita gap between the Land of Berlin and the German average will be further reduced. In addition, strong economic growth led to a reduction in the unemployment rate of the Land of Berlin, down to 9% in 2017 from 12.3% in 2012.
Despite these strengths, Berlin faces several challenges. Berlin’s debt burden is very high by both national and international standards, despite the firm downward trend since 2010. Direct debt together with outstanding guarantees amounts to EUR 64.1bn or 240% of the Land’s operating revenue as of end-2017, slightly down from 257.7% at end-2016. The robust growth of operating revenues and thus positive balances before debt movements have enabled this downward trend. Scope expects this downward trend to continue, in keeping with the Land’s medium-term financial planning.
The Land of Berlin also faces the challenge of limited fiscal flexibility. While Scope notes positively the rising proportion of overall capital expenditures, which increase fiscal flexibility, this flexibility remains constrained by the fact that most expenditures result from rigid personnel and transfer payments. In addition, due to the extensive shareholdings of the Land of Berlin, the high level of contingent liabilities is also a concern, which, however, is mitigated by the largely low-risk profiles of the companies that the Land of Berlin partially or wholly owns. Scope views positively the entities’ consolidated low leverage ratio of total liabilities to assets of 0.52. This ratio accounts for an increase in the consolidated debt of the major entities, excluding the regional promotional bank ‘Investitionsbank Berlin’, to EUR 16.5bn in 2017 from EUR 15.54bn in 2016. This increase is somewhat offset by the high level of assets, in part due to the Land’s shareholding in the real estate and housing sectors, which have experienced a rise in value.
With the exception of the Berlin Brandenburg Airport, all major shareholding entities were profitable in 2017, which is reflected in a consolidated net surplus of EUR 0.59bn on a projected basis. The low and decreasing share of loss-making companies (in 2016, eight of 56 companies had negative results versus 10 in 2015) and good annual results overall, support sustained high levels of investment volume. It is Scope’s view that the associated companies fulfil a significant public-sector mandate for the Land of Berlin by contributing to the further development of Berlin’s dynamic growth, as well as strengthening the regional economy.
Outlook and rating-change drivers
The Stable Outlook reflects good visibility on the evolution of the very supportive German institutional framework and Scope’s expectation that Berlin’s government will keep to its fiscal consolidation programme and continue to place the Land’s debt on a firm downward trajectory over the medium term.
The ratings could be downgraded if: i) the German sovereign rating were to be downgraded or ii) changes in the institutional framework resulted in notably weaker support.
The main points discussed during the rating committee were: i) the institutional framework; ii) fiscal flexibility; iii) Berlin’s economic structure; iv) debt and fiscal developments; v) the state of contingent liabilities, in particular the Bankgesellschaft transaction, the Berlin Brandenburg Airport and social housing association debt; vi) the activity of the Land’s investment fund SIWANA; and vii) international peers comparison.
The methodology applicable for this rating and/or rating outlook Rating Methodology: Sub-Sovereign Rating, is available on www.scoperatings.com.