DBRS Morningstar Confirms the Autonomous Community of Madrid at 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. Despite the large economic shock due to the Coronavirus Disease (COVID-19), the fiscal impact of the pandemic has so far been largely mitigated by the extraordinary financial transfers provided by the national government to all Spanish regions. These transfers have supported Madrid's finances in 2020 and are expected to continue to alleviate budgetary pressures in 2021 and 2022. Some uncertainty remains regarding the speed of the economic recovery following the large COVID-19 shock but DBRS Morningstar takes the view that Madrid's financial performance, although remaining under pressure, should continue to benefit from government support and additional financial resources stemming from the European Union (EU) programmes.

Madrid´s ratings remain underpinned by (1) the region’s large and diversified economy; (2) Madrid’s track record of an improving fiscal performance; and (3) the region’s sound debt structure and continued strong access to bond markets. DBRS Morningstar continues to view positively the financing backstop from the Kingdom of Spain (A, Stable), which could be made available to support the region should financing conditions require it. 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 ratings could be upgraded if any or a combination of the following occur: (1) the Kingdom of Spain's ratings are upgraded; (2) Madrid delivers strong and recurring fiscal results; or (3) the region places its debt on a medium-term downward trajectory and it continues to strengthen its liquidity profile.

The ratings 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

Substantial Economic Impact From COVID-19 Last Year but Recovery is Expected in 2021 and 2022

The COVID-19 outbreak has taken its toll on the Spanish and the regional economies in 2020. Madrid and Spain more generally, have been severely affected by the pandemic. The latest figures available estimate that regional gross domestic product (GDP) decreased by 10.3% in 2020, only slightly less severe than Spain's 10.8% 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. 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 emergence of new virus variants and uncertainty over longer term vaccine efficacy. DBRS Morningstar views positively the improvement of the healthcare situation in Spain and in the region in recent months, supported by the strong vaccine rollout throughout the country. As of 3 September 2021, more than 77% of the Spanish population had received at least one dose of the vaccine while 71.5% had received the two doses. The vaccination is expected to limit the introduction of new government restrictions and should, therefore, support the economic rebound. Current forecasts from the Spanish government anticipate an economic rebound of 6.5% in 2021 and 7.0% in 2022. Madrid's economy is currently expected to perform in line with the national average. Strong economic recovery will be key to limiting any long-term scarring effects of the virus on the regional and national economies.

Despite the strength of the COVID-19 shock, the fiscal measures taken by the national government over the last 18 months as well as the financial resources expected from the Next Generation EU (NGEU, including the Recovery and Resilience Facility (RRF) as well as REACT-EU funds), 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 quarters, particularly sectors substantially affected like tourism, as well as on the effectiveness of the absorption of EU funds.

Fiscal Performance Continues to be Supported by the National Government’s Financial Transfers

On the fiscal front, Madrid’s performance marginally improved in 2020, with a deficit-to-GDP ratio of -0.05%, that was within the regional deficit target of -0.20% and slightly improved on the levels of -0.24% recorded in 2019 and of -0.25% in 2018. Madrid's financial performance remained strong 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 avoiding a substantial deterioration in regional finances going forward.

In 2021, the national government is maintaining a high level of transfers (entregas a cuenta) to its regions. These transfers within the regional financing system will also be complemented with extraordinary transfers of EUR 13.5 billion, that will assist regions in covering the additional costs related to the pandemic. In addition, European transfers related to the NGEU programme should allow regions to increase their capital expenditure throughout this year and to help underpin their economic recovery.

The regional deficit is currently expected to stabilise in 2021, with the current estimate from the Independent Authority for Fiscal Responsibility (AIReF) of a deficit around 0.1% of GDP this year. Pressures on the region's fiscal performance will remain in 2022 and 2023, as these years are likely to be affected by negative settlements under the regional financing system, as well as by a decrease in the amount of extraordinary transfers provided by the national government.

DBRS Morningstar acknowledges the national government's recent communications, announcing around EUR 7 billion of extraordinary transfers in 2022, part of which will be dedicated to absorb the negative 2020 settlement, as well as the still high level of ordinary transfers scheduled under the regional financing system. These additional transfers should continue to support the financial performance of the region next year, even if the current reference rate for Spanish regions' deficit at -0.6% of GDP is likely to imply a small worsening of Madrid's fiscal results. Over the medium-term, as extraordinary transfers decrease further, addressing the share of new expenditure, particularly healthcare related, that is likely to remain structurally higher will remain critical for regional finances to stabilise.

Over the medium-term, DBRS Morningstar's analysis of the region's fiscal performance will focus on (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 Q1 2021, its debt-to-GDP ratio was 16.5%, one of the lowest amidst its national peers. While Madrid's adjusted debt-to-operating revenues ratio is estimated to have decreased to 160.5% at the end of 2020 from 186.2% at the end of 2019, 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 8.15 years at the end of July 2021, affordable interest costs at 1.88% 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 the region's 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 continue to 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 AA (low) – A range. Additional considerations factored into the Rating Committee decision included the very high level of extraordinary transfers from the national government in 2020 which inflated the region’s revenues last year, therefore significantly improving its financial metrics; the medium-term economic and fiscal risks related to the current pandemic.

The main points discussed during the Rating Committee include: the region’s economic growth forecasts for 2021 and 2022; the potential recovery of the tourism in the region; 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/384029/spain-kingdom-of-scorecard-indicators-and-building-block-assessments

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 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 1, 2021) https://www.dbrsmorningstar.com/research/383672/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 2014-10 period (end of August), Madrid’s Investor Presentation from July 2021, Bank of Spain for the debt metrics during the period between 2015 and Q1 2021, Independent Authority for Fiscal Responsibility (AIReF) for its quarterly estimate of the regional GDP growth and its estimate of the 2021 regional deficit, Instituto Nacional de Estatística (INE), Ministry of Finance for the monthly budgetary execution; the 2020 European Social Progress Index from the European Commission. 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/384281.

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: March 12, 2021

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