DBRS Morningstar Upgrades the Autonomous Community of Madrid to “A”, Trend Changed to Stable

DBRS Ratings GmbH (DBRS Morningstar) upgraded the Long-Term Issuer Rating of the Autonomous Community of Madrid (Madrid) to “A” from A (low) and changed the trend to Stable from Positive. At the same time, DBRS Morningstar confirmed Madrid's Short-Term Issuer Rating at R-1 (low) with a Stable trend.

KEY RATING CONSIDERATIONS

The Upgrade of the Long-Term Rating reflects DBRS Morningstar's view that Madrid has delivered strong fiscal results since 2018, and this performance is likely to continue. DBRS Morningstar also acknowledges that the region has been able to strengthen its liquidity profile in recent years. Despite the uncertainties related to inflationary pressures, DBRS Morningstar believes that the region will be able to control debt accumulation in the next years thanks to its monitoring of expenditure and higher than expected tax revenues, while extraordinary transfers from the central government related to the COVID-19 pandemic have now ended.

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 and is likely to temporarily linger given that the central government’s COVID-19 budgetary support has elapsed. However, the debt should keep on a downward trend in relation to both operating balance and GDP. In addition, DBRS Morningstar views positively the potential return of the Budget Stability Law, possibly in 2024, which should encourage the region to maintain a balanced budget.

RATING DRIVERS
The ratings could be upgraded if both the region improves its debt ratios at a faster pace than currently expected, whilst maintaining a good liquidity profile, and the Kingdom of Spain's ratings are upgraded. Madrid does not have the constitutional protection to be rated above the sovereign rating and its ratings are therefore capped by the Kingdom of Spain’s ratings.

The ratings could be downgraded if any or a combination of the following occur: (1) there is a structural reversal in the region’s fiscal consolidation, leading fiscal operational deficits to widen over time; (2) there is a marked and lasting deterioration in Madrid’s debt metrics, including wider and costlier annual maturities and higher leverage; or (3) the Kingdom of Spain's ratings are downgraded.

RATING RATIONALE
Strong Fiscal Results Since 2018 Should Continue in 2023 Despite the End of Extraordinary Central Government COVID-19 Financial Support

Madrid’s fiscal performance remained strong in 2022. This was despite 2022 being the first year without extraordinary budgetary assistance from the central government that had occurred in 2020 and 2021. The region is estimated to have delivered a small financial deficit of 0.67% of GDP last year according to its estimates including 0.06% of non-anticipated retroactive public servants wage raise of 1.5% decided by the central government. In comparison, latest forecasts from the Independent Authority for Fiscal Responsibility (AIReF) point to a deficit of 1.1% of GDP for the Spanish regions this year, versus a reference rate set at 0.6% for 2022. AIReF’s forecast was revised downward due to inflation which lifted personnel costs and goods and services-expenditures above the savings due to the decrease of pandemic-related expenditures. Latest forecasts from AIReF are close to the region’s estimates with a deficit in 2022 that could reach 0.7% of GDP, also close to the region’s expectation, although slightly weaker than initially anticipated given the retroactive staff cost adjustment. AIReF expects the region to perform in 2023 in line with its budget, which includes a 0.3% of GDP deficit target, therefore continuing the fiscal consolidation that will enable it to control debt accumulation.

In 2022, the national government has maintained a high level of transfers (entregas a cuenta) to its regions and these transfers were also complemented by extraordinary transfers of EUR 7.5 billion meant to compensate regions for a negative fiscal settlement related to 2020 and a VAT payment shortfall from 2017. While these additional funds continued to support regional finances in 2022, they represent a substantial decrease compared to the extraordinary COVID-19-related transfers received in 2020 and 2021 of EUR 16.0 billion and EUR 13.5 billion, respectively. Accordingly, Madrid's fiscal performance weakened in 2022 compared to 2020 and 2021, when it posted a deficit of -0.02% and a surplus of 0.32% respectively. Nevertheless, the region has been able to partly compensate for this loss in containing expenditure. For 2023, DBRS Morningstar does not expect any extraordinary transfer from the regional funding system, however the amount of transfers (entregas a cuenta) will increase by around 24% compared with 2022. This should ensure that autonomous communities receive enough funding to cover their responsibilities, which DBRS Morningstar views positively given the current economic challenges including high inflation. DBRS Morningstar takes the view that, expenditure control to maintain a sound budgetary position over the medium-term will also remain critical for regions, including Madrid.

Stronger Liquidity Profile While Central Government Liquidity Facility Remains Available Although Unused

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 (CP) programme in 2020 and the increase in 2021 of the amount of the region's credit line facilities. These provide the region with additional financial room for maneuver to weather potential exogeneous shocks. The CP program also allows it to minimize its interest cost, as the region will recourse it when credit lines are more costlier. 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. As of October 2022, the region had a favorable liquidity position including EUR 2.8 billion available in its liquidity 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. The availability of this backstop partially explains the region's low cash retention policy.

Economic Recovery Continues, the Labor Market is Back to Pre-Pandemic Levels, But Uncertainties Remain Given Inflationary Pressures, Although EU Funds Could Act as A Counterbalance

In terms of economic growth, AIREF estimates Madrid's 2022 real GDP growth at 3.9%, lagging behind the national expectation of 5.3%. This is partly explained by the relatively stronger performance of Madrid already in 2021, following the COVID-19 outbreak that significantly affected the Spanish and the regional economies in 2020. Madrid's GDP decreased by 9.8% in 2020, closely in line with Spain's 10.2% 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, Madrid's GDP rebounded by 6.5%, according to the region's estimates, outperforming the 5.1% for Spain's national GDP, driven by a strong rebound in the construction and services sectors. The regional economy is expected to continue recovering in coming years, broadly in line with the national average. DBRS Morningstar expects a strong tourism performance and solid job creation to support Spain's GDP but inflationary pressures, particularly higher energy prices, increasing funding costs, and a weaker external backdrop are likely to weigh on growth this year. Amid this background, the European Commission (EC) revised its growth performance for Spain upwards to 5.5% in 2022 and forecasts 1.4% GDP growth in 2023, according to its Winter 2022 publication.

DBRS Morningstar therefore takes the view that long-term risks related to COVID-19 have receded, as exemplified by the strong performance of the labour market in recent months. As of Q3 2022, Madrid's unemployment rate had recovered its pre-pandemic level, although given the seasonality is currently close to 11.3% and still far below the national average of 12.7%, and a peak of 13.5% in Q4 2020.

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. The region estimates revenue received related to these funds at around EUR 1 billion in 2022 with EUR 0.9 billion spent. 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 regional economy.

Fiscal Performance Should Support Continued Debt Metric Improvement

DBRS Morningstar continues to foresee Madrid’s debt sustainability position as strong in coming years, given the region's wide economic base. At the end of Q3 2022, its debt-to-GDP ratio was 13.6%, among the lowest of Spanish regions. Madrid's adjusted debt-to-operating revenue is estimated to have risen to around 170% in 2022, versus 153% in 2021, but this is mainly due to the loss of extraordinary transfers from the central government. This ratio remains high in an international context, but it is well below the 220% recorded at the end of 2015. In terms of the level of debt stock, Madrid's debt remained relatively stable over the last four years, only increasing very marginally and as of October 2022 the debt stock has slightly increased by 0.5% or EUR 185 million compared with its end-2021 level. DBRS Morningstar takes the view that stabilizing and possibly improving debt metrics further, will remain an important step for the region to strengthen its credit profile. Madrid’s debt structure is sound, with a smooth amortization profile, an average debt maturity of 8.38 years in 2022, affordable interest costs at 2.01% of the debt stock, and continued access to financial markets. In DBRS Morningstar’s view, bank loans and bond financing, including sustainable and green bonds, underpin the region’s widely diversified financing sources.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Social (S) Factors

The Passed-through Social credit considerations have a relevant effect on the ratings, as the social factors affecting the Kingdom of Spain’s ratings are passed-through to Madrid.

There were no Environmental or Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022).

RATING COMMITTEE SUMMARY

DBRS Morningstar’s 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 forecasts for 2022 and 2023, the current 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 and funding framework characteristics.

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/410073/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:
All figures are in euros (EUR) unless otherwise noted.

The principal methodology is the Rating European Sub-Sovereign Governments (August 12, 2022) https://www.dbrsmorningstar.com/research/401273/rating-european-sub-sovereign-governments. In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022) in its consideration of ESG factors.

The sources of information used for this rating include the Autonomous Community of Madrid for financial and budgetary position and debt structure from 2016 to October 2022, Madrid’s Investor Presentation, Bank of Spain for the debt stock during the period between 2016 and 2021, Independent Authority for Fiscal Responsibility (AIREF) for its January 2023 monitoring of the 2022 budget stability targets and for its October 2022 report on Madrid’s 2023 budget considerations, Instituto Nacional de Estadistica (INE), Ministry of Finance, Ministry of Tax, and 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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: https://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/410263.

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

Lead Analyst: Jorge Espinosa, Assistant Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Co-Head Global Sovereign Ratings
Initial Rating Date: February 1, 2019
Last Rating Date: September 09, 2022

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