DBRS Morningstar Confirms the Autonomous Region of Madeira at BB (high), Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Long-Term Issuer Rating of the Autonomous Region of Madeira (Madeira) at BB (high) and its Short-Term Issuer Rating at R-4. The trend on all ratings remains stable.

KEY RATING CONSIDERATIONS
Madeira’s ratings are underpinned by (1) the region’s stabilising financial performance over the last few years and its slowly improving debt metrics prior to the start of the crisis; (2) the financial oversight and support to the regional government from the Republic of Portugal (BBB (high), Stable); and (3) Madeira’s enhanced control over its indirect debt as well as its commercial liabilities through a gradual re-centralisation of these liabilities onto its own balance sheet.

The adverse impact of the Coronavirus Disease (COVID-19) on the regional economy, and particularly its tourism sector, and the considerable uncertainty concerning the timeframe for full recovery are key challenges for Madeira's creditworthiness. The Stable trend on Madeira's ratings, however, reflects DBRS Morningstar's view that ongoing support from the national government should help the region navigate through the current period of heightened challenges. This support will remain key for Madeira's economic recovery in 2021 and 2022 but also to avoid a structural weakening of the region's credit profile.

While Madeira's debt is set to increase in 2020 and possibly in 2021 reflecting the economic and fiscal shock related to the COVID-19 pandemic, DBRS Morningstar currently considers that Madeira’s debt metrics are likely to return to their downward trend over the medium-term, once full recovery is underway. Nevertheless, the region’s still very high direct and indirect debt levels continue to weigh on Madeira's ratings. The regional government’s still large exposure to regional companies (although it had decreased in recent years) and its economic concentration in the tertiary sector, particularly tourism, also remain key challenges to Madeira’s overall credit profile.

RATING DRIVERS
Madeira's ratings could be upgraded if any or a combination of the following occur: (1) Madeira substantially reduces its indebtedness; (2) the Portuguese sovereign rating is upgraded; (3) Madeira’s economic indicators recover significantly faster than currently anticipated and the region enhances its economic resiliency; or (4) there are indications of a further strengthening of the relationship between the region and the central government.

Madeira's ratings could be downgraded if any or a combination of the following occur: (1) the Portuguese sovereign rating is downgraded; (2) Madeira fails to stabilise its financial performance and debt metrics over the medium-term; or (3) indications emerge that the financial support and oversight currently provided by the central government weaken.

RATING RATIONALE

Regional Economy is Significantly Affected by the Collapse of the Tourism Sector

On the economic front, the region had delivered solid gross domestic product (GDP) growth prior to 2020 with GDP growing between 2015 and 2019, at an average annual rate of 2.2%. While DBRS Morningstar expects considerable economic disruption in 2020 and most likely 2021, the full impact of the coronavirus pandemic will depend on the depth and duration of the shock.

Air passenger inflows into the region have declined substantially, with a drop of 63% between January and June 2020 compared with the same period in 2019. This decline had direct consequences for restaurants and hotels in the region, with hotels' revenues estimated to have fallen by about 64% at the end of June 2020, compared with the first six months of 2019. The impact of the pandemic on the regional labour market is currently difficult to estimate, as corporates have benefited from the national government's subsidised working scheme, in line with the rest of Portugal, as well as regional support, which has so far mitigated against job losses.

Going forward, the region's tourism sector will remain constrained by the evolution of the healthcare situation, particularly in Europe which represents the main source of tourists in the region. DBRS Morningstar will also monitor the potential uplift in the economic recovery linked to additional funds expected to be received by the region from the European Union (EU, AAA, Stable) under its next generation EU programme (NGEU) and possibly its new multi-annual financial framework (2021-27 period).

Financial Performance and Debt Levels, Although Improving in Recent Years, Will Be Impacted by the COVID-19 Pandemic

In terms of fiscal performance, Madeira’s results had markedly improved prior to the pandemic. The region’s deficit therefore represented less than 7% of operating revenues on average in the last four years, significantly down from a very large 74% at the end of 2013. In 2020, the region expects its financing deficit to widen substantially due to COVID-19, with the impact of the pandemic estimated at EUR 458 million for the year, or around 38% of 2019 operating results, split between a decline in tax receipts (around 40% of the total) and an increase in expenditure (60%).

This is expected to be financed by debt, most likely with the guarantee from the national government. The region also plans to increase its expenditure in healthcare, education and other social expenses in 2021, in order to support the economic recovery within its territory. While large deficits are credit negative for Madeira, DBRS Morningstar will focus its analysis on whether these deficits remain concentrated in one or two years and do not translate into a structural weakening of the region's financial performance.

The region's solid GDP growth and the parallel rise in tax proceeds prior to 2020 had also supported the decrease in Madeira's debt ratios. From an international comparison, the region’s debt-to-operating revenues, at 472% at the end of 2019, remains, however, very high. Madeira’s debt ratio continues to represent, in DBRS Morningstar’s view, the main constraint on the region’s ratings. In line with the deterioration of Madeira's fiscal performance in 2020, its debt ratio is expected to increase markedly this year. However, the national government’s support via the explicit guarantees provided by the Portuguese Treasury and Debt Management Agency (IGCP) and the General Directorate of Treasury and Finance (DGTF) should mitigate the risk of an increase in the region's debt financing costs, in line with the very low costs of funding currently experienced by Portugal.

Sovereign Guarantees Will Continue to Support the Rating

The explicit guarantees provided by the central government for the refinancing of the regional debt and DBRS Morningstar’s expectation that this support will continue are positive credit features, critical for Madeira's rating. The region’s refinancing needs have fully benefited from the national government’s explicit guarantee in recent years and should continue to do so going forward (upon request from the regional government). The medium-term debt trajectory of the region will remain the key focus of DBRS Morningstar's analysis. Any indication that higher debt levels will linger for longer or that the central government's support to the region is weaker than currently foreseen, would be credit negative for Madeira.

ESG CONSIDERATIONS
Institutional Strength, Governance and Transparency (G) was a key driver behind this ration action. Madeira’s re-centralisation of its reclassified public entities’ debt onto its own balance sheet and the subsequent enhanced transparency and oversight over their operations and finances highlight the strengthening of the region’s Governance in recent years and was significant to the region’s credit rating.

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
DBRS Morningstar’s European Sub-Sovereign Scorecard generates a result in the BBB (low) – BB range. The main points discussed during the Rating Committee include the COVID-19 outbreak and its impact on the regional economy, as well as Madeira’s financial performance and debt metrics. The relationship between the central government and the Autonomous Region of Madeira.

For more information on the Key Indicators used for the Republic of Portugal, please see the Sovereign Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/366854.

The national scorecard indicators were used for the sovereign rating. The Republic of Portugal’s rating was an input to the credit analysis of the Autonomous Region of Madeira.

Notes:
All figures are in Euros (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Rating European Sub-Sovereign Governments (September 4, 2020) https://www.dbrsmorningstar.com/research/366368/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 2015-19 financial statements and budgetary execution from the Autonomous Region of Madeira, debt metrics from the Bank of Portugal, economic indicators (unemployment, GDP metrics) from the Instituto Nacional de Estatística (INE). 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/367256.

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: Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: June 15, 2018
Last Rating Date: March 27, 2020

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