DBRS Morningstar Confirms the Autonomous Community of Madrid A (low), Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Long-Term Issuer Rating of the Autonomous Community of Madrid (Madrid) at A (low) and its Short-Term Issuer Rating at R-1 (low). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar’s assessment that the risks to the ratings remain broadly balanced. As a reminder, DBRS Morningstar deviated from its EU Calendar on June 5, 2020 to change the trend on Madrid’s ratings to Stable from Positive to reflect the substantial shock from the Coronavirus Disease (COVID-19) on the Spanish and regional economy. Madrid's finances will be affected by a combination of higher healthcare-related expenditure and lower tax collection. Although DBRS Morningstar expects the national government to largely mitigate the impact on the region's financial performance in 2020, Madrid's and other Spanish regions’ fiscal outcomes are likely to remain under pressure in 2021 and 2022.

Madrid´s ratings remain underpinned by (1) the region’s large and diversified economy; (2) Madrid’s track record of an improving fiscal performance between 2015 and 2019; and (3) the region’s sound debt structure and continued access to the bond market. DBRS Morningstar continues to view positively the financing backstop from the Kingdom of Spain (A, Stable), which could support the region, should financing conditions deteriorate. Conversely the region’s steady debt stock increase over the last decade and its corresponding high debt-to-revenue ratio continue to weigh on Madrid’s ratings.

RATING DRIVERS
The rating could be upgraded if any or a combination of the following occur: (1) the Kingdom of Spain is upgraded; (2) Madrid delivers fiscal surpluses; or (3) the region’s debt metrics improve faster than anticipated and it continues to strengthen its liquidity profile.

The rating could be downgraded if any or a combination of the following occur (1) the Kingdom of Spain is downgraded; (2) there is a structural reversal in the region’s fiscal consolidation, leading to fiscal deficits widening over time; or (3) there is a marked and lasting deterioration in Madrid’s debt metrics.

RATING RATIONALE

The COVID-19 Pandemic is Taking its Toll on the Regional Economy in 2020
Madrid’s economic size and performance remain key credit strengths for the region. Madrid represents 19% of Spain’s gross domestic product (GDP) and has consistently outperformed the national average on most economic indicators in recent years. Madrid has for instance a markedly higher GDP per capita than other Spanish regions, representing 136% of the national average. The region's labour market also started 2020 on a more favourable footing than some of its regional peers, with the unemployment rate at 10.0% compared with a national average of 13.8% at the end of 2019.

Nevertheless, COVID-19 has been taking its toll on the Spanish and the regional economy since March this year. Madrid has been severely affected by the healthcare crisis. The region, in line with the rest of the country, has been under one of the longest and strictest lockdowns in Europe. While the strict initial lockdown has helped reduce the transmission of the virus among the population, it also brought the economic activity to an halt. Regional GDP is estimated to have contracted by 18% in the second quarter (QoQ), by the Independent Authority for Spanish Fiscal Responsibility (AIReF). This result is more or less in line with the GDP decline recorded in Spain (-18.5%) over the same period. Year-on-year, the regional and national GDP contractions are estimated at a staggering -22%. This drop largely reflected the extent of the healthcare crisis within the national and regional territories, the stringency of the lockdown that followed, and the high concentration of economic activity in sectors severely affected such as tourism.

While a solid rebound is expected for the second part of 2020 and in 2021, uncertainty remains regarding its strength, given the resurgence in recent weeks of infections in the region and in Spain. DBRS Morningstar considers that the fiscal measures announced by the national government to mitigate the adverse consequences of the COVID-19 outbreak, as well as the resources expected from the Next Generation EU plan from 2021, should help alleviate the long-term impact of the pandemic. While DBRS Morningstar expects this shock to affect all Spanish regions, its overall impact on the region of Madrid will depend in large part on how quickly economic activity normalises in coming quarters.

Pressures on the Region’s Fiscal Performance Will Increase, but the National Government Will Limit the Negative Impact

On the fiscal front, Madrid has been a solid performer in recent years, with sound fiscal consolidation supported by strong annual economic growth of 3.4% on average between 2015 and 2019. Madrid’s headline deficit therefore declined from -2.49% of regional GDP in 2011, to -0.27% in 2019. DBRS Morningstar moreover highlights that the 2019 figure was negatively affected by a one-off revenue shortfall related to lower VAT receipts, representing approximately 0.15% of regional GDP. Madrid therefore markedly outperformed the national average of a deficit of -0.55% of GDP in 2019, with only three regions out of seventeen releasing stronger results.

In 2020, further fiscal consolidation appears challenging given the rapid deterioration in economic indicators in the region and in Spain. DBRS Morningstar currently expects strong pressure on Spanish regions' operating expenditure, as regions directly manage healthcare related costs which are expected to increase. In addition, the anticipated drop in economic output in 2020 is likely to markedly affect regional taxes, in particular property transfer tax, collected by the region and that represented around EUR 1.5 billion in 2019 or 8% of the region’s operating revenues.

On the other hand, Madrid and other Spanish regions under the common regime will benefit from the automatic stabiliser built into the regional financing system. While the pandemic is likely to decrease substantially the level of taxes collected by the national government and in particular shared taxes such as value added tax and personal income tax, the regions should remain insulated from this drop in 2020. The national government has not revised down the level of transfers (entregas a cuenta) that it will make to regions this year. Transfers from the financing system will therefore continue to increase in 2020; by EUR 7.7 billion or 7.1% year-on-year compared with 2019.

The negative effect of the lower tax collection in 2020 will therefore be borne by the central government. While this will support regions in 2020, the regional financing system will prompt a negative settlement to be paid by regions in 2022, which is likely to be very substantial. However, DBRS Morningstar considers it likely that the national government will allow regions to repay this settlement over the long-term, as it did regarding the 2008 and 2009 negative settlements which are currently being repaid over 20 years.

DBRS Morningstar also highlights that the national government approved additional fiscal transfers to its regions (Fondo COVID-19) in 2020, totaling EUR 16 billion or 1.3% of national GDP. These correspond to one-off grants, aimed at supporting regional finances on the face of the COVID-19 crisis. These funds will be split between EUR 10 billion directed to healthcare expenditure, EUR 5 billion to compensate for lower regional revenues and EUR 1 billion for additional social costs borne by regions. Madrid currently estimates that it could receive close to EUR 3.5 billion (1.6% of regional GDP) from the Fondo COVID-19, EUR 1.8 billion of which has already been confirmed for healthcare and education. Overall, the AIReF expects that Madrid overall fiscal balance for 2020, taking into account these additional transfers, could range between a slight surplus of 0.1% of the regional GDP and a deficit -0.2%.

DBRS Morningstar therefore anticipates that Madrid and other Spanish regions' 2020 financial performance should be only marginally affected by the COVID-19 crisis, as the central government finances take the hit. The situation is nevertheless likely to deteriorate rapidly in 2021 and 2022, with lower revenues from the regional financing system and still high expenditure increasing pressure on regional finances. While the national government is likely to continue supporting its regions, growing regional deficits and debt levels are likely to materialise. DBRS Morningstar will monitor the level of transfers (entregas a cuenta) to regions in 2021, as well as any potential additional measures taken by the national government to limit the impact on regional finances over the medium-term.

Debt Sustainability to Remain Strong, Supported by Sound Debt Structure

DBRS Morningstar continues to expect Madrid’s debt sustainability position to remain strong going forward, given the region's wide economic base. At the end of Q1 2020, its debt-to-GDP ratio was 14.3%, one of the lowest amidst its national peers. Nevertheless, debt reduction, particularly the region’s high debt-to-revenue ratio at 186% at the end of 2019 (DBRS Morningstar’s adjusted debt figure), remains key in DBRS Morningstar's view for the region to strengthen its credit profile further. Madrid’s debt structure is sound, with a smooth amortisation profile, an average debt maturity of 7.92 years in July 2020, affordable interest costs at below 2% of the debt stock, and continued access to the bond market.

In DBRS Morningstar’s view, bank loans and bond financing, including sustainable bonds and more recently a first green bond, underpin the region’s widely diversified financing sources. On the liquidity side, the central government’s financing facilities, although not currently used by Madrid, are viewed as a potential backstop, which reduces Spanish regions’ refinancing risks.

DBRS Morningstar continues to consider that a strengthening of Madrid’s liquidity profile would represent a positive credit development, as it would allow the region to weather potential exogeneous shocks more appropriately. In that context, DBRS Morningstar positively notes that the region has successfully launched in 2020 a commercial paper programme (CP, Programa de Pagarés) sized at EUR 500 million. DBRS Morningstar considers that this programme broadens Madrid’s liquidity toolkit. Going forward, the use of such CP programme and the region’s existing credit lines will be monitored to assess for a strengthening in Madrid's liquidity profile.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

RATING COMMITTEE SUMMARY

The DBRS Morningstar European Sub-Sovereign Scorecard generates a result in the A (high) – A (low) range.
The main points discussed during the Rating Committee include: the region’s economic growth and the impact of the COVID-19 on its fiscal and debt trajectories. The financial support provided by the national government during the pandemic and the relationship between the national government and the Autonomous Community of Madrid was also discussed.

For more information on the Key Indicators used for the Kingdom of Spain, please see the Sovereign Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/366403

The national scorecard indicators were used for the sovereign rating. The Kingdom of Spain’s rating was an input to the credit analysis of the Autonomous Community of Madrid.

Notes:
All figures are in euros (EUR) unless otherwise noted.

The principal methodology is the Global Methodology for Rating European Sub-Sovereign Governments (4 September 2020): https://www.dbrsmorningstar.com/research/350151/rating-european-sub-sovereign-governments.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The sources of information used for this rating include the Autonomous Community of Madrid for financial position and debt structure for the 2014-19 period, Madrid’s Investor Presentation from July 2020, Bank of Spain for the debt metrics during the 2014-19 period and Q1 2020, Independent Authority for Fiscal Responsibility (AIReF) for its Report on the 2020 Budgetary Execution for the region of Madrid and its quarterly estimate of the regional GDP growth (August 2020), Instituto Nacional de Estatística (INE), Ministry of Finance for the monthly budgetary execution. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/366634.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Nicolas Fintzel, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings Initial Rating Date: February 1, 2019
Last Rating Date: June 5, 2020

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