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 track record of improving its debt metrics prior to 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 still 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 the strong commitment of the region to monitor its debt level and the ongoing support from the national government should help the region navigate through the current period of heightened challenges. This State 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.

Madeira's debt increased sharply in 2020 due to the economic and fiscal shock related to the COVID-19 pandemic and the pre-funding of COVID-19 related measures. Given this pre-funding mostly realised in 2020, DBRS Morningstar currently considers that Madeira’s debt metrics are likely to stabilise in 2021 and then 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 has 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 resilience and diversification; 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%. However, the economic disruption was considerable in 2020, with an economic contraction estimated at close to 20% versus 7.6% nationally, given the overweight of the tourism sector in the region's gross value added and its geographical location as an Archipelago in the middle of the Atlantic Ocean. Healthcare restrictions and lockdowns took their toll on tourists' arrival and air passengers traffic plummeted in 2020 with a drop of 60% in new arrivals compared to 2019. In addition, given the slow rollout of the vaccination process and the arrival of new COVID-19 variants, the recovery of the tourism and therefore of Madeira's economic output in 2021 is still uncertain.

Lower passenger inflows have had direct consequences for restaurants and hotels in the region, with hotels' revenues estimated to have fallen by about 70% in 2020. The unemployment rate has increased to 8.6% in September 2020 versus 6.9% in September 2019. Nevertheless, the full impact of the pandemic on the regional labour market is still 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 more substantial 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).

Financial Performance and Debt Levels, Although Improving in Recent Years, Are 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’s financing deficit widened to 14% and should remain very high in 2021 (above 30% in the budget) reflecting the pandemic situation, with the budgetary impact of regional COVID-19 related measures amounting to EUR 458 million over 2020 and 2021. 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 has already pre-funded those COVID-19 related measures in 2020 through a EUR 458 million loan and should therefore be able to stabilise its debt level in 2021, with the expected rise in operating revenue. The region's solid GDP growth and the parallel rise in tax proceeds prior to 2020 had supported the decrease in Madeira's debt ratios and Madeira would have been able to maintain this trend excluding the impact of COVID-19. Nevertheless, from an international comparison, the region’s debt-to-operating revenues, at 556% at the end of 2020, remains extremely high. Madeira’s debt ratio continues to represent, in DBRS Morningstar’s view, the main constraint on the region’s ratings. 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 can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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 on 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/374340/portugal-republic-of-scorecard-indicators-and-building-block-assessments.

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:
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.

All figures are in Euros (EUR) unless otherwise noted.

The principal methodology is the Rating European Sub-Sovereign Governments (September 4, 2020) https://www.dbrsmorningstar.com/research/366368/rating-european-sub-sovereign-governments. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

The sources of information used for this rating include the 2015-20 financial statements and budgetary execution from the Autonomous Region of Madeira, economic indicators (unemployment, GDP metrics) from the Instituto Nacional de Estatística (INE) and the Direção Regional de Estatística da Madeira (DREM). 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/374872/.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Mehdi Fadli, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: June 15, 2018
Last Rating Date: September 25, 2020

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