DBRS Morningstar Changes Trend on Autonomous Community of Madrid to Positive, Confirms at A (low)Sub-Sovereign Governments
DBRS Ratings GmbH (DBRS Morningstar) confirmed the Long-Term Issuer Rating of the Autonomous Community of Madrid (Madrid) at A (low). The trend on the Long-Term Rating has been changed to Positive from Stable. At the same time, DBRS Morningstar confirmed Madrid's Short-Term Issuer Rating at R-1 (low). The trend on the Short-Term Rating remains Stable.
KEY RATING CONSIDERATIONS
The Positive trend on the Long-Term Rating reflects DBRS Morningstar's view that (1) Madrid has delivered strong fiscal result in the last three years and is likely to continue doing so in the foreseeable future; (2) the region is strengthening its liquidity profile; and (3) downside risks related to the COVID-19 pandemic appear to be receding. The economic outlook remains nevertheless clouded with uncertainties related to the healthcare situation and inflationary pressures, particularly energy prices. So far, Madrid's finances have weathered well the shock of the COVID-19 pandemic, supported by the extraordinary financial transfers provided by the national government to all Spanish regions. Going forward, DBRS Morningstar's analysis will focus on the speed of the economic recovery as well as the region's effectiveness in controlling its expenditures as extraordinary national government support wanes.
Madrid´s ratings remain underpinned by (1) the region’s large and diversified economy; (2) its track record of an improving fiscal performance; and (3) its sound debt management. 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 high debt-to-operating revenue ratio still weighs on Madrid’s ratings.
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 trend on the Long-Term Ratings could return to Stable if Madrid's fiscal performance deteriorates, leading to weaker fiscal and debt positions than currently expected. 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.
Recovery is Underway but Economic Outlook Remains Clouded with Uncertainties
The COVID-19 outbreak has significantly affected the Spanish and the regional economies in 2020. Madrid's gross domestic product (GDP) decreased by 11.0% in 2020, in line with Spain's 10.8% decline, largely reflecting the extent of the healthcare crisis, the stringency of the lockdown that followed, and the high concentration of economic activity in sectors severely affected such as tourism. In 2021, economic output rebounded by 5% in Spain, largely driven by investments and domestic consumption. Real GDP in the region is expected to have grown at a similar pace. Economic recovery is currently expected to continue in the next two years, as the healthcare situation continues to normalise and activity resumes. The European Commission currently forecasts Spain's economy to grow by 5.6% in 2022 and 4.4% in 2023. These forecasts remain nevertheless subject to downside risks related to the pandemic and inflationary pressures.
Despite the strength of the COVID-19 shock, the supportive measures taken by the national government over the last 24 months as well as the financial resources expected from the Next Generation EU (NGEU, including the Recovery and Resilience Facility (RRF) and REACT-EU funds), should continue to alleviate the long-term impact of the pandemic and support the recovery. DBRS Morningstar therefore takes the view that long-term risks related to COVID-19 appear to have receded, as exemplified by the strong performance of the labour market in recent months. At the end of 2021, Madrid's unemployment rate had largely recovered its pre-pandemic level, standing at 10.1% compared with 10.0% at the end of 2019 and a peak of 13.5% in Q4 2020. Going forward, the impact of higher inflation on consumption and investment as well as the speed of absorption of EU funds will remain key areas of focus for DBRS Morningstar to assess the strength of the recovery within the region's territory.
Madrid’s Fiscal Performance Strengthens Supported in Part by the National Government’s Financial Transfers
On the fiscal front, Madrid’s performance is expected to have remained strong throughout 2021. The region is expected to deliver a small financial surplus, close to 0.2% of GDP, supported by the economic recovery and the extraordinary transfers from the national government. This would correspond to a marginal improvement from the slight surplus of 0.02% recorded in 2020 and the deficit of -0.26% of GDP in 2019. DBRS Morningstar views positively the fiscal improvement recorded by the region in the last three years, but continues to consider that maintaining this strong performance will remain challenging, as government extraordinary measures are wound down and inflationary pressures linger. DBRS Morningstar will monitor the potential pass through of inflation to structural regional expenditure, such as personnel and healthcare related costs, as this may negatively affect regional finances, particularly if coupled with an increase in financing costs and a slowdown in economic growth.
In 2022, 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 7.0 billion meant to compensate regions for a negative fiscal settlement related to 2020 and a VAT payment shortfall from 2017. While these additional funds will continue to support regional finances in 2022, they represent a substantial decrease compared to the extraordinary COVID-related transfers received in 2020 and 2021 of EUR 16.0 billion and EUR 13.5 billion, respectively. As a result, addressing the share of new expenditure incurred during the pandemic, particularly healthcare related, that is likely to remain structurally higher, will remain critical for regions to maintain a sound budgetary position over the medium-term. The current reference rate for Spanish regions in 2022 is a deficit of 0.6% of GDP. Latest forecasts from the Independent Authority for Fiscal Responsibility (AIReF) estimate that Madrid's deficit in 2022 could reach 0.3% of GDP.
As a result, DBRS Morningstar's analysis of the region's fiscal and economic performance will continue to focus on (1) the level of national government's transfers to its regions; (2) the effectiveness of the regional government's control over structural expenditure; and (3) the speed of absorption of EU funds.
Madrid’s Debt Sustainability to Remain Strong, Liquidity Profile is Strengthening
DBRS Morningstar continues to expect Madrid’s debt sustainability position to remain strong in coming years, given the region's wide economic base. At the end of Q3 2021, its debt-to-GDP ratio was 15.1%, the lowest amidst Spanish regions. While Madrid's adjusted debt-to-operating revenues ratio is estimated to have decreased to 156% at the end of 2021 from 186% at the end of 2019, it continues to reflect in part the increase in revenues due to the substantial rise in transfers received from the national government last year. From a debt stock point of view, Madrid's debt has remained relatively stable over the last three years, only increasing very marginally. As a result, DBRS Morningstar takes the view that stabilising and possibly improving debt metrics further, will remain an important step 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 8.38 years in January 2022, affordable interest costs at 1.86% 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.
On the liquidity side, DBRS Morningstar also views positively the strengthening of Madrid's liquidity profile in recent years, as shown by the widening of its liquidity toolkit, including the launch of a commercial paper programme in 2020 and the increase in 2021 in the region's credit line facilities. These provide the region with additional room to weather potential exogeneous shocks. Going forward, DBRS Morningstar will continue to monitor Madrid's liquidity position, including the use by the region of its CP programme and its existing credit lines. In addition, the central government’s financing facilities, although not currently used by Madrid, continue to be viewed as a potential financing backstop for the region, reducing its overall refinancing risks.
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 European Sub-Sovereign Governments Scorecard generates a result in the AA (low) – A range. Additional considerations factored into the Rating Committee decision included the high level of extraordinary transfers from the national government in 2020 and 2021 which inflated the region’s revenues in the last two years, therefore improving its financial metrics, the remaining macroeconomic uncertainties, the risks to the fiscal outlook, particularly on the expenditure side.
The main points discussed during the Rating Committee include: the region’s economic growth forecasts for 2022 and 2023; the potential recovery of the tourism sector in the region; Madrid’s public finances track record and their trajectories; the region’s debt and liquidity profile, 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/393251/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.
All figures are in euro (EUR) unless otherwise noted.
The principal methodology is the Rating European Sub-Sovereign Governments https://www.dbrsmorningstar.com/research/383672/rating-european-sub-sovereign-governments (September 1, 2021). 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, budgetary execution and debt structure for the 2015-21 period, Madrid’s Investor Presentation, Bank of Spain for the debt stock during the period between 2015 and Q3 2021, Independent Authority for Fiscal Responsibility (AIReF) for its quarterly estimate of the regional GDP growth and its estimate of the 2021/2022 regional deficit, Instituto Nacional de Estatística (INE), Ministry of Finance; 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/393637.
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 10, 2021
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