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Accelerated transition entails short circuitcircuit risks in municipal utilities’ fundingSustainable higher deficitsin local public transportburden the profitability by2025Pandemic-related revenue shortfalls and special burdens (average decline inlocal public transport passenger volumes of 33% in 2020 yoy and 17% yoy infirst half of 2021) will be almost fully compensated by pandemic bailout fundsprovided for local public transport companies arranged by federal and stategovernments. These bailout schemes are, however, scheduled to end in 2021.An extension of support programs for local public transport or renewal of anysuch programs is currently still subject to discussions. If no new support schemesfor local public transportation operations were enacted, municipal utilities willhave to rely on additional (horizontal) segment profits, unused committed creditlines or price increases from 2022 onwards to compensate for the structuraldeficits in public transportation. Taking into account extensive price moratoria aswell as sustainable shifts to individual mobility (including expansion in use ofelectric vehicles and fast charging stations), we expect passenger volumes,(new) subscription models and services, capacity utilization and cost recoveryratios in local public transport to reach the 2019 baseline in 2025 at the earliest.The transition of thebusiness models and lowgeographical and verticaldiversification burden theprofitabilityIn 2021 municipal utilities benefit from positive seasonal weather impacts, thatcompensate negative wind-driven feed-in effects and high transition costs. Highmarket values of energy commodities enhance proprietary trading (no timelyprocurement), counterparty, portfolio management and liquidity risks (exceededlimits in OTC trading). Ambitious transition goals to reach coal phase-out andclimate targets (e.g. domestic renewable electricity share of demand 80% (prior65%) by 2030 (previously 2038)) increase substitution risks of unregulatedbusiness in the sub-sector.The utilities face higher financial risks due to the growth and transition of the baseand peak load power generation portfolio, cooperation partner synergies and theassessment of the competitive position of the (contracted) sales and tradingchannels. The municipal utilities have low (sales, renewable assets)geographical and value-added vertical diversification.Negative profitability trendin the medium-termWe expect the negative trend in operating profitability of municipal utilities tocontinue as a result of competitive pressure, and substantial costs incurred forthe transition of the energy and mobility segments (Figure 2).Figure 3: major municipal utilities: overall deteriorated capex and shortterm debt coveragesSource: Scope Hamburg: adjusted net capex (taking account of disposals and grants) operating Cashflow (OCF)-net capex (medians) and adjusted (marketable securities and equivalents and restrictedcash) liquidity and free operating cash flow (FOCF)-short-term debt (medians). Scope Hamburg GmbH 20214/8

Accelerated transition entails short circuitcircuit risks in municipal utilities’ fundingInadequate capex and short-term debt coveragesHigh growth and transitioncapex and investmentbottleneck up to 2030The leading municipal utilities such as Stadtwerke München, Stadtwerke Köln,MVV Energie, SachsenEnergie, VVG Hannover, LVV Leipzig have coordinatedlong-term strategies and forecasts with integrated smart-city developments withmunicipal shareholders up to 2030. Highly regulated safeguarding of supplyservices to customers include network stability and climate targets. Strategicgoals include investments in flexible and diversified CO2-free thermal (hydrogen)power-plants, renewable energy generation and energy storage.Development of smartmetropolitan regions and citiesAdditional capex goals include development of smart regions and cities – theRhine-Ruhr region, military bases and railroad sites - taking into considerationwith long approval procedures, demographic developments, R&D and economicforecasts. The major utilities have developed digital platforms with “one local faceto the customer” to meet demand and save costs. Efficient network and localtransport fleet upgrades reduce infrastructure investment bottlenecks.Increasing external fundingneeds by tightened regulatedregimes and e-mobilitytargetsConsumption forecasts for drinking water and treated sewage includingexpectations for a higher number of heavy rain and drought periods requireconsiderable expansion and refurbishment investments in water infrastructure.There are increased investment and operator risks due to stricter ecologicalrequirements related to of the 4th treatment stage and in mono-incineration withash storage and phosphorus recovery in sewage sludge recycling.In the mobility segment, the high expansion and upgrade investments for trackexpansion in the main roads and e- and hydrogen fleets are partly financed byfederal-state funding to achieve the ambitious e-mobility goals.Inadequate capex coverageand short-term debt maturitieslimit shareholders’ dividendsThe ownership structure of municipal utilities together with increasing dividendexpectations, high capital intensity, regulatory framework and the low cash flowshare of (digital) value-added services limit the adaptability of the businessmodels. We observe inadequate funding of short-term financial debt at municipalutilities. In 2020, only 80% of short-term financial debt was covered with cash atbank or other unrestricted and immediately convertible cash-near assets. Weexpect the dependence of municipal utilities on short-term external financing toeven deteriorate further in the medium term. (Figure 3).Figure 4: major municipal utilities: leverage and interest cover worsensSource: Scope Hamburg: adjusted leverage (unfunded pension, decommissioning and retirementprovisions and operate lease obligations) net debt-to-EBITDAR (medians) and adjusted EBITDARinterest cover (net paid interests, medians). Scope Hamburg GmbH 20215/8

Accelerated transition entails short circuitcircuit risks in municipal utilities’ fundingLeverage and interest cover will deteriorate due to expansionand transition of the business modelsHigh funding needs for peakcapexThe municipal utilities face high net capex amounting to EUR 7-8bn (taking intoaccount disposal proceeds and investment grants; previous years EUR 4-6bn)per year by 2025e to accelerate the transition of its energy, recycling and sewagetreatment, mobility and telecommunication segments.Highly regulated positive cash flows in the energy and water segments anddisposals of capital intensity non-core activities and share deals will stabilize thebusiness risk profiles and reduce external funding needs.High financial requirementsfor decommissioning ofpower plantsStructural transition capex for projects such as the coalfields in the Ruhr andLusatia regions or decommissioning nuclear power plants, including technicalretirement risks combined with climate targets, raise the funding needs for theenergy, water and mobility segments of selected municipal utilities players.Deteriorated leverage andinterest coverThe leverage and interest cover will weaken due to increased financing needsfor growth, transition, regulatory and decommissioning capex. Municipal utilitiesface large capital investment/capex needs in the medium-term resulting from: coal/nuclear decommissioning commissioning of CO2-free thermal (hydrogen) power-plants expansion battery, hydrogen and bio-methane storages permitting, project planning and long-termonshore/offshore wind and solar farms portfolios expansion fibre-to-the-building connections expansion smart and hydrogen and refurbishment distribution networkmarketingof upgrading e-mobility fleets commissioning synthetic material recycling and waste treatmentfacilities and mono-incineration with ash storage and phosphorusrecovery in sewage sludge recycling digital customized platforms development of smart districts, cities and metropolitan areasWith reduced public support, low internal financing capability, and the expecteddeterioration of operating profitability, we foresee a further deterioration of creditmetrics for municipal utilities.The market-leading institutional investors provide green bonds for infrastructurefunding based on Investment Grade Ratings and ESG performance KPIs.Inadequate cash flows and liquidity reserves, transition risks of the businessmodels, higher interest rates and extensive dividend policy will negatively impactthe assessment of municipal utility credit risks (Figure 4).Historically weak internal cash generation from ongoing business is expected toweaken, further reflecting the negative effects on operating profitability, and,possibly, higher interest burdens from increasing indebtedness. Scope Hamburg GmbH 20216/8

Accelerated transition entails short circuitcircuit risks in municipal utilities’ fundingFigure 5: major municipal utilities: deleveraging 8201920202021eSource: Scope Hamburg: adjusted FFO (depreciation component of lease, paid taxes and net interests,medians) -to-net debt (medians).Deteriorating deleveragingpotential entail higher shortcircuit risks in fundingThe question is whether adequate (not restricted) liquidity reserves, unusedcommitted credit lines, certain disposals and financial sources will cover the shortand medium-term maturities of interest-bearing liabilities. Transition risks of thebusiness models, higher interest rates and more generous dividends will leavenotably negative marks on municipal utility credit risks (Figure 5).Higher short circuit risks in adequate funding for financiallydistressed municipal utilitiesAre financially distressedmunicipal utilities stillappropriately supported?The question is whether financially distressed municipal utilities are stillappropriately supported by timely extraordinary shareholders’ cash injectionsand traditional financial sources, e.g. syndicated bank loans, in spite of shortcircuiting the profitability and credit metrics. Inability or political reluctance ofmunicipal shareholders to provide for timely funding of local municipal utilitiesmay lead to an accelerated sub-sector’s market consolidation.This publication does not constitute a rating action for any of the companiesmentioned.Scope Ratings GmbH and Scope Ratings UK Limited apply the samemethodologies/models and key rating assumptions for their credit rating services.Scope Hamburg GmbH’s methodologies/models and key rating assumptions aredifferent from those of Scope Ratings GmbH and Scope Ratings UK Limited. Scope Hamburg GmbH 20217/8

Accelerated transition entails short circuitcircuit risks in municipal utilities’ fundingDisclaimer 2021 Scope Hamburg GmbH (“SHG”) and/or its licensors and affiliates. All rights reserved.CREDIT RATINGS ISSUED BY SHG ARE SHG’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES,CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND SHG’S PUBLICATIONS MAY INCLUDE SHG’S CURRENTOPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKESECURITIES. SHG DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIALOBLIGATIONS AS THEY COME DUE AND, IN THE CASE OF ISSUANCE-LEVEL CREDIT RATINGS, ANY ESTIMATED FINANCIALLOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO:LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND SHG’S OPINIONS INCLUDED IN SHG’SPUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. 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lease and rent expenses) EBITDAto-R-revenues (medians) for the major 50 municipal utilities for the period 2017-2020 and trend 2021e (base 2020 representative published audited consolidated financial statements and data for 70 % of the considered municipal utilities), no adjustments for local public