OREANDA-NEWS. Not yet paid out or covered by accumulatedreserves--in our calculation of the state's tax-supported debt burden. However, we do not expect Saxony will have to cover further losses exceeding the guarantee amount, as we believe that, by 2019 at the latest, the state will hand over responsibility for the portfolio of its former Landesbank, Landesbank Sachsen, to Landesbank Baden-Wuerttemberg (not rated), which purchased Landesbank Sachsen in 2008.

We regard Saxony's debt burden as low in an international context, as Saxony has one of the lowest debt ratios of all German states. We anticipate under our base-case scenario that Saxony will further reduce its tax-supported debt, including the planned reduction in the unfunded part of the Sealink guarantee. The debt ratio depends on management's decisions, as it might decide to accumulate less cash in reserves for additionally reducing gross borrowing. Although unfunded pension liabilities are still relatively high in an international comparison, at about 48% of consolidated operating revenues, we believe the state's plan to regularly fund pension reserves is feasible and therefore no longer apply the debt constraint.

Saxony's contingent liabilities predominately stem from its guarantees for Saechsische Aufbaubank. We regard them as low, given the bank's low risk profile and sound capitalization. Yearly losses from other guarantees are low and present only minor financial risks for the state. According to informationwe received from the management, the state currently faces no significant litigation risks.

We assess Saxony's SACP at 'aaa'. Additionally, we consider it likely that Saxony would benefit from extraordinary credit support from the federal government or other German states in a stressed situation. The federal or other states' treasuries could quickly invest their cash holdings in Saxony without legal approval. This cash investment would not qualify as a state transfer, which we would define as extraordinary systemic support. As we do for all German states, we therefore factor an additional notch of support intoour ratings. However, given Saxony's stand-alone credit strength, this notch is currently not meaningful for our rating on Saxony.

LIQUIDITY

We view Saxony's liquidity as exceptional thanks to strong access to external liquidity. In addition, Saxony's debt service coverage ratio is currently exceptional, but we expect it will display some volatility over the coming 12 months. The state's debt service is generally low compared with that of other German entities, and debt service falling due in the next 12 months is low compared to previous years. The state predominantly lends from public-sector entities, including the state's pension fund and the guarantee fund, and rarely borrows from capital markets. On average, we expect cash holdings to equate to about 140% of debt service for the next 12 months, including other available liquidity coverage increases beyond 200% of debt services. Nonetheless, the current coverage ratio is positively affected by a very low level of maturing debt in 2017, with a spike anticipated for 2018. We therefore currently see volatility in the coverage ratio, and expect that overthe medium term its levels will be similar to those observed in 2015 and before.

In addition to its debt service coverage ratio, Saxony has strong access to external liquidity. We note the overall excellent credit standing of German states, which the capital markets view as an asset class of their own. The states have access to a deep and liquid capital market, and additionally to sources of liquidity from other levels of government. Furthermore, our BankingIndustry Country Risk Assessment (BICRA) score for Germany is '2' ('1' being the lowest risk and '10' being the highest). For more details, see "Banking Industry Country Risk Assessment: Germany" published on Sept. 7, 2016, on RatingsDirect).

OUTLOOK

The stable outlook reflects our expectation that Saxony will continue its verystrong budgetary performance with surpluses after capital accounts on average, which enables the state to accumulate reserves and reduce its low debt burden. We think the state will adapt to the loss of special transfers and the revision of the tax-sharing system in 2019.

We currently see a downside scenario for the rating as highly unlikely, as Saxony's SACP is at the same level as the rating. A downgrade would require substantial deterioration of the rating factors on Saxony. Our ratings on Saxony incorporate uplift to the SACP for extraordinary credit support of other German states or the federal government, a factor currently not consequential for our rating on Saxony because of its already high SACP at 'aaa'.