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 changed the trend on Madrid’s ratings to Stable from Positive on 5 June 2020, to reflect the substantial shock from the Coronavirus Disease (COVID-19) pandemic on the Spanish and the regional economy. Despite the large economic shock, the fiscal impact of the COVID-19 last year has been largely mitigated by the extraordinary transfers provided by the national government to all Spanish regions. In 2021, further extraordinary funding coupled with additional European funds should continue to support regional finances. DBRS Morningstar considers that Madrid's financial performance is however likely to remain under pressure in 2022 and 2023, as the central government's budgetary support measures decrease.

Madrid´s ratings remain underpinned by (1) the region’s large and diversified economy; (2) Madrid’s track record of an improving fiscal performance prior to the pandemic; 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-operating 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's ratings are upgraded; (2) Madrid delivers fiscal surpluses; or (3) the region places its debt on a medium-term downward trajectory 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's ratings are downgraded; (2) there is a structural reversal in the region’s fiscal consolidation, leading fiscal deficits to widen over time; or (3) there is a marked and lasting deterioration in Madrid’s debt metrics.

RATING RATIONALE

The COVID-19 outbreak has taken its toll on the Spanish and the regional economy in 2020.

Madrid and Spain more generally, have been severely affected by the pandemic. The latest figures available estimate that the regional gross domestic product (GDP) decreased by 10.3% in 2020, only slightly better than Spain's 11% decline. The substantial GDP decrease largely reflected the extent of the healthcare crisis within the regional and national territories, the stringency of the lockdown that followed, and the high concentration of economic activity in sectors severely affected such as tourism.

Madrid’s economic size and performance remain nevertheless key credit strengths for the region. Madrid benefits for instance from a markedly higher GDP per capita than other Spanish regions, representing 136% of the national average. The region, which represents close to 20% of Spain’s GDP, has also consistently outperformed the national average on most economic indicators in recent years. This was confirmed in 2020, with the region recording a slightly less severe economic downturn than the Spanish average.

For 2021, economic forecasts remain clouded with uncertainty, given the risk related to the potential resurgence of infections with the apparition of new virus variants and the somewhat slow rollout of the vaccination process. While DBRS Morningstar views positively the improvement of the healthcare situation in Spain and in the region in recent weeks, the pickup in the economic recovery in coming quarters will be key to limit the scarring effects of the virus on the regional and national economies. DBRS Morningstar's current moderate GDP growth scenario for Spain anticipates a rebound of 6.5% in 2021.

Despite the strength of the COVID-19 shock, the fiscal measures taken by the national government over the last 12 months as well as the resources expected from the Next Generation EU (NGEU, including the Recovery and Resilience Facility (RRF) as well as REACT-EU funds) from 2021, should help alleviate the long-term impact of the pandemic. DBRS Morningstar considers that the overall impact of the crisis on Madrid's economy and finances will largely depend on how quickly economic activity resumes in coming months and quarters as well as on the absorption rate of EU funds.

The National Government’s Budgetary Support Mitigates So Far the Impact on Regional Finances

On the fiscal front, Madrid’s fiscal performance stabilised in 2020, with a deficit-to-GDP expected within the regional deficit target of -0.2%, not far from the level recorded in 2019 at -0.24% and in 2018 at -0.25%. While final 2020 figures are still pending, DBRS Morningstar considers that Madrid's financial performance remained sound last year, reflecting the targeted budgetary support received from the national government. Spanish regions are responsible for healthcare and education expenditure in Spain. As a result, maintaining such financial support as long as necessary for the economic activity to recover will be key to avoid substantial deterioration in regional finances going forward.

In 2021, the national government will continue to maintain a high level of transfers (entregas a cuenta) towards its regions. These transfers within the regional financing system will also be complemented by extraordinary transfers of EUR 13.5 billion, expected to assist regions in covering the additional costs related to the pandemic. In addition, European transfers related to the NGEU plan (estimated to represent EUR 15-20 billion in 2021) should allow regions to increase their capital expenditure throughout the year and possibly boost their economic recovery.

While the regional deficit is expected to widen in 2021, with a reference rate for the deficit set at -1.1% of GDP for Spanish regions, overall, the fiscal focus for DBRS Morningstar will remain the years 2022 and 2023, likely to be affected by negative settlements under the regional financing system, as well as a decrease in the amount of extraordinary transfers provided by the national government. DBRS Morningstar continues to consider it likely that the national government will allow regions to repay any settlement over the long-term, as it did regarding the 2008 and 2009 negative settlements which are currently being repaid over 20 years. Nevertheless, addressing the share of new expenditure, particularly healthcare related, that is likely to remain structurally higher going forward will remain critical for regional finances to stabilise over the medium-term.

DBRS Morningstar will monitor (1) the level of transfers to regions; (2) the speed of absorption of EU funds; (3) the increase in the regions' structural expenditure; and (4) any potential additional measures taken by the national government to limit the future impact of the crisis on the regional finances.

Madrid’s 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 Q3 2020, its debt-to-GDP ratio was 15.8%, one of the lowest amidst its national peers. While Madrid's debt-to-operating revenues ratio is estimated to have decreased to 164% at the end of 2020 (DBRS Morningstar’s adjusted and preliminary debt figures) from 186% at the end of 2019, DBRS Morningstar points out that it mostly reflects the increase in revenues due to the substantial rise in transfers received from the national government last year. As a result, in DBRS Morningstar's view, debt reduction will remain key going forward 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 8.33 years at the end of 2020, affordable interest costs at below 2% of the debt stock, and continued access to bond markets.

In DBRS Morningstar’s view, bank loans and bond financing, including sustainable and green bonds, underpin the region’s widely diversified financing sources. More information on this can be found in the following Commentary: DBRS Morningstar: Madrid Continues to Pave The Way in Sustainable Funding for Spanish Sub-Sovereign Governments. 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 also views positively the broadening of Madrid's liquidity toolkit in recent years, with the launch of a commercial paper programme last year and the recent increase in credit line facilities. These provide the region with additional room to weather potential exogeneous shocks. Going forward, the use by the region of its CP programme and its existing credit lines will be monitored to assess any strengthening in Madrid's liquidity profile.

ESG CONSIDERATIONS

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

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 in 2020 and the forecast for 2021; the impact of the COVID-19 pandemic on Madrid’s fiscal and debt trajectories; the financial support provided by the national government during the pandemic.

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/374875
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:
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 Methodology for Rating European Sub-Sovereign Governments (4 September 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 Autonomous Community of Madrid for financial position and debt structure for the 2014-20 period, Madrid’s Investor Presentation from February 2021, Bank of Spain for the debt metrics during the period between 2015 and Q3 2020, Independent Authority for Fiscal Responsibility (AIReF) for its quarterly estimate of the regional GDP growth (February 2021), Instituto Nacional de Estatística (INE), Ministry of Finance for the monthly budgetary execution. The 2020 European Social Progress Index from the European Commission was also used. 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/375252

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Nicolas Fintzel, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson; Managing Director, Co-Head of Global Sovereign Ratings
Initial Rating Date: February 1, 2019
Last Rating Date: September 11, 2020

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