OREANDA-NEWS. November 11, 2015. Fitch Ratings has affirmed the Long-term foreign and local currency Issuer Default Ratings (IDR) of seven German federated states (Laender) of Berlin, Hamburg, Lower Saxony, North Rhine-Westphalia, Rhineland-Palatinate, Saxony-Anhalt and Schleswig-Holstein at 'AAA' with Stable Outlooks as well as its senior unsecured debt rated 'AAA'/'F1+'. The agency has also affirmed the Short-term foreign currency IDRs at 'F1+'.

Fitch has also affirmed the currently 12 rated outstanding bond issues of the state of Bremen (DE000A11QJV5; DE000A1680K4; DE000A11QJ32; DE000A1680J6; DE000A11QJY9; DE000A11QJ24; DE000A11QJ16; DE000A11QJZ6; DE000A11QJW3; DE000A11QJU7; DE000A11QJX1 and DE000A11QJ08), eight rated outstanding bond issues of the state of Thuringia (DE000A11QS31; DE000A1TM6Z1; DE000A1X3GF6; DE000A14KJ84; DE000A13SJM6; DE000A1REW10; DE000A13SMR9 and DE000A14KGW6), one of the state of Mecklenburg-Western Pomerania (DE000A12TWL1), one of the state of Saarland (DE000A11P8Q8) and one of the HSH Finanzfonds AoeR (DE000A11QGT5), the last of which is explicitly and irrevocably guaranteed by the states of Hamburg and Schleswig-Holstein at 'AAA'. Fitch further affirmed the joint bond issue Bund-Laender-Anleihe 1 (DE000A1X2301) and 17 outstanding joint bond issues of the German Laender (Laender 27; 32; 33 and 36-49) at 'AAA'.

KEY RATING DRIVERS
The ratings are driven by the strong institutional framework under which the German Laender operate.

The Laender's ratings reflect the stability of the solidarity system that underpins the creditworthiness of all Laender. The solidarity system is enshrined in the German constitution and reflects the institutional framework of the Laender. According to the German constitution, all member states of the federal republic are jointly responsible for supporting a Land in financial distress. If a Land experiences "extreme budgetary hardship", it is entitled to financial assistance from all other Laender and the Bund. This principle has been reaffirmed by the constitutional courts on more than one occasion in the past, the last time in 2006.

Germany's 'AAA' rating, which Fitch last affirmed on 10 July 2015, is primarily driven by its strong institutions and diversified, high value-added economy. Germany reported a structural current account surplus of 6.5% of GDP on average over 2010-2014 supporting the country's net external creditor position. The general government debt (74.9% of GDP in 2014) is higher than the 'AAA' median (45% of GDP), but it is showing a downward trend thanks to strong budgetary discipline ahead of the debt brake starting in 2020.

Extensive equalisation systems and a broad-based solidarity pact compensate for financial disparity. This equalisation framework requires financially stronger Laender to transfer part of their above-average tax proceeds to the financially weaker ones. The framework partly offsets the differences among Laender's tax revenue base and financial strength. Fitch also recognises the reforms of the approved Federalism Reform II, which require the Laender to operate their budgets without taking on net new debt starting in 2020. Fitch recognises that these reforms increased the budgetary discipline of the Laender as they will constitutionally not be allowed to increase debt from this date. In Fitch's view, this change should make extreme budgetary hardship less likely, following the Laender's implementation of appropriate cost-cutting measures to consolidate their budgets to comply with the debt brake.

Moreover, the well-established and active liquidity management system that is in place, together with the Laender's very good access to the capital market and corresponding strong refinancing capacity as well as appropriate treasury facilities should prevent any temporary delays in the provision of support. The liquidity risk of a single Land is avoided through bilateral and mutual agreements linking all Laender as well as the federal government, and ensuring their ability to assist one another. Liquidity would only fail to be forthcoming for any given Land in the event of a complete federal breakdown, in which neither the other Laender nor the federal government itself could provide liquidity.

According to preliminary figures for 3Q15, the German Laender aggregate capital market debt had reduced by 1.2% to about EUR534bn (3Q14: EUR541bn), which was large in proportion to their revenues (225% of current revenue). Servicing costs vary by issuer, but lengthy maturity structures and low interest rates currently support the Laender's efforts of cost consolidation. Fitch considers that the large stock of publicly issued debt (equivalent to around half of German sovereign debt) is a distinctive feature of the Laender, which should reinforce its efforts to comply with the debt brake.

According to the most recent tax estimate of November 2015 provided by the working group "tax estimates" (Arbeitskreis Steuerschaetzungen), the Laender's tax revenues are expected to increase by 5.3% in 2015 and by 2.9% in 2016, underpinned by Fitch's expectations that the Germany economy will grow by about 1.7% and 1.9%, respectively. Compared with the last tax estimate of May 2015, Laender taxes were estimated to be EUR3.4bn higher in 2016 at EUR275.3bn, while the updated estimate for 2016 expects EUR4.9bn (EUR1.9bn) less for the Bund (municipalities). This should help support their efforts to limit expenditure growth and partly compensate for additional costs following the increasing number of immigrants and potential corresponding support for the municipalities as well as growing challenges following this. Cost consolidation efforts realised so far, combined with lower interest rates, and hence favourable funding costs, resulted in 10 Laender reporting a surplus before debt variation in 3Q15. Moreover, the accumulated net funding surplus of EUR702m reported in 2014 further improved to EUR2,649m in 3Q15. This is much better than the initially budgeted deficit of EUR8.3bn for 2015. Considering the current tax estimate and economic progress in place, Fitch expects the Laender to report a cumulated surplus again in 2015 but challenged by uncertain costs due to the increasing number of refugees.

The Bund introduced measures in its draft budget 2016 and medium-term financial plan 2015-2019 to support the Laender and their municipalities to comply with their responsibilities. An additional EUR23bn is earmarked for investments, public cooperation on foreign aid in light of the humanitarian crisis and the climate challenges as well as for municipal investments in the medium term plan. To cope with the increasing number of refugees, further support from the Bund for both, Laender and municipalities is currently under discussion. According to an assessment of a municipal association (Deutscher Staedtetag), municipalities may face EUR16bn of additional costs in 2016, considering 1.2 million refugees. In Fitch's view, this underpins the agency's rating approach incorporating the support mechanism in place for German subnationals.

RATING SENSITIVITIES
A downgrade of the sovereign ratings could lead to a downgrade of the Laender. An adverse change to any of the important institutional features - solidarity principle, equalisation system, liquidity exchange mechanism - which is currently unlikely in Fitch's view, could also lead to a downgrade of the Laender's ratings.