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 the 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 Coronavirus Disease (COVID-19) and its willingness to revert back to a deleveraging trend in the near future; (2) the financial oversight and support to the regional government from the Republic of Portugal (BBB (high), Positive); and (3) Madeira’s gradual implementation of public finance reforms including the current development of budgetary forecasting models.

The adverse impact of the COVID-19 pandemic on the regional economy, and particularly its tourism sector despite a more positive momentum from Q3 2021, and the uncertainty concerning the timeframe for full recovery remain key challenges. The Stable trend on Madeira's ratings, however, reflects DBRS Morningstar's view that the strong commitment of the region to improve its fiscal performance and monitor its debt level while benefiting from the ongoing support from the national government should help the region navigate through the current period of challenges. At this stage, the Trend change on Portugal to Positive from Stable on 25 February 2022 does not directly impact Madeira's Trend given its already very high debt level in conjunction with the significant deterioration of its fiscal situation in the last two years. The region's capacity to execute projects funded by the European Union (EU, AAA, Stable) programmes will also be key for Madeira's economic recovery.

Madeira's debt increased sharply and peaked in 2020 due to the economic and fiscal shock related to the COVID-19 pandemic. Given the pre-funding of COVID-19-related measures for 2021 realised in 2020 and higher operating revenues in 2021, Madeira’s debt metrics started slightly improving in 2021. DBRS Morningstar considers that the improvement in debt metrics is likely to continue over the medium-term, once recovery is fully underway. Nevertheless, the region’s still very high 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 is able to strongly deliver on its willingness to deleverage thanks to a stronger fiscal performance; (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

The Economic Recovery Seems Under Way, Supported by a More Positive Momentum for the Hospitality Sector since Spring 2021, but Uncertainties Remain as to the Timing of Full Recovery

The gradual recovery in tourism is under way, especially since spring 2021, supported by the efficient handling of the healthcare situation by Madeira's authorities. Overnight stays in Q3 2021 accounted for 72% of their Q3 2019 level and accelerated in Q4 2021 reaching 81% of their Q4 2019 level. Prior to the COVID-19 pandemic, the region had delivered solid gross domestic product (GDP) growth, with GDP growing between 2015 and 2019 at an average annual rate of 2.2%, supported by the tourism sector with overnight stays increasing by 5.1% on average annually. However, the economic disruption was considerable in 2020, with an economic contraction estimated at 14.3% for the region versus 8.4% nationally, related to the large size of the tourism sector in the region's gross value added and to its geographical location as an Archipelago in the middle of the Atlantic Ocean.

Due to the impact of the COVID-19 pandemic, the unemployment rate peaked at 11.2% in Q4 2020 versus 7.4% in Q4 2019, before starting a downward trend to 6.6% in Q4 2021. Nevertheless, the full impact of the pandemic on the regional labour market remains difficult to estimate due to 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 affected by the complete resolution of the healthcare situation, particularly in Europe, which represents the main source of tourists in the region, especially countries including Germany, the United Kingdom and France. 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 EU. In addition to traditional EU funding programs, the region could receive up to EUR 697 million in grants related to the Recovery and Resilience Facility (RRF) and EUR 64 million related to the Recovery Assistance for Cohesion and the Territories of Europe (REACT-EU).

Fiscal and Debt Situation, Strongly Impacted by the COVID-19 Pandemic, Should Gradually Improve from 2022

In terms of fiscal performance, the region’s financing deficit widened to 14.2% in 2020 and worsened to 24.9% in 2021, reflecting the pandemic situation. The budgetary impact of regional COVID-19 related measures are estimated at EUR 458 million over 2020 and 2021. DBRS Morningstar expects that the region will be able to reduce its deficits from 2022 onwards. Prior to the pandemic, Madeira’s results had markedly improved. The region’s deficit represented less than 7% of operating revenues on average during 2016-2019, significantly down from a very large 74% at the end of 2013.

The region has pre-funded its COVID-19 related measures in 2020 through a EUR 458 million loan and had therefore been able to slightly decrease its DBRS Morningstar's adjusted debt stock in 2021. With the rise in operating revenues last year, the region had been able to bring back its debt-to-operating revenues ratio to 489% versus 504% in 2020. 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 remains extremely high. Madeira’s debt ratio continues to represent, in DBRS Morningstar’s view, the main constraint on the region’s ratings. However, thanks to its active debt management, the region has been able to reduce the cost of its debt in the last years. 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) continues to support the region's cost of financing.

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 has implemented public administration management reforms in recent years and is willing to continue to do so. This was particularly the case through the 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. The strengthening of the region’s Governance in recent years 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 BB (high) – BB (low) range. The main points discussed during the Rating Committee include the regional economy recovery and the 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/392920/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:
All figures are in euro (EUR) unless otherwise noted.

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 2016-2021 financial statements and budgetary execution from the Autonomous Region of Madeira, Instituto Nacional de Estatística (INE) and 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/393284.

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 Global Sovereign Ratings
Initial Rating Date: June 15, 2018
Last Rating Date: September 03, 2021

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