DBRS Confirms Autonomous Community of Madrid at A (low), Trend Changed to Positive

DBRS Ratings GmbH (DBRS) 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). Simultaneously, DBRS changed the trend on Madrid’s Long-Term Issuer Rating to Positive from Stable; the trend on the Short-Term Issuer Rating remains Stable.

KEY RATING CONSIDERATIONS

The trend change reflected the trend change to Positive from Stable of the Kingdom of Spain´s Long-Term Foreign and Local Currency – Issuer Rating of A on 20 September 2019. The trend change at the sovereign level reflected DBRS’s view that risks to Spain’s ratings are now skewed to the upside and that the conditions that supported the country’s solid economic growth and steady improvements in public finances in recent years should continue going forward. Given the economic and financial linkages between the national government and the region of Madrid, Spain’s trend change affects positively DBRS’s analysis of Madrid’s creditworthiness and supports the region’s trend change to Positive.

Madrid´s ratings remain underpinned by (1) the region’s large and diversified economy; (2) Madrid’s improving fiscal performance in the last three years; and (3) the region’s sound debt structure and continued access to the bond market. DBRS also views positively the financing backstop from the Kingdom of Spain, 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 metrics continue to weigh on Madrid’s ratings.

RATING DRIVERS

Upward rating pressures could materialise if any or a combination of the following occur: (1) the Kingdom of Spain is upgraded; (2) Madrid delivers sustained fiscal surpluses; or (3) the region’s debt metrics improve faster than anticipated and it strengthens its liquidity profile.

Although less likely given the Positive trend on the rating, downward rating pressure could materialise if any or a combination of the following occur (1) the Kingdom of Spain’s ratings return to Stable; (2) there is a reversal in the region’s fiscal consolidation leading to widening fiscal deficits; or (3) there is a marked deterioration in Madrid’s debt metrics.

RATING RATIONALE

Madrid’s Economic Size and Performance Are Key Credit Strengths for the Region

The region represents 19% of Spain’s gross domestic product (GDP) and has consistently outperformed the national average on most economic indicators in recent years. These include much stronger real GDP growth in 2018. The provisional growth number of 3.7% compares favourably with the 2.6% for the national average. In addition, Madrid has a markedly higher GDP per capita representing 135% of the national average and more favourable unemployment figures of 10.5% versus 14.0% in Q2 2019.

Strong annual economic growth of 3.5% on average since 2015 has underpinned Madrid’s improving fiscal position. Higher economic growth has led to a pick-up in tax revenues — regional taxes and the region’s share of national taxes — which coupled with expenditure control have enabled Madrid to rapidly reduce its headline deficit to -0.16% of regional GDP in 2018 from -2.48% in 2011.

Strong Fiscal Consolidation Since 2015 is Expected to Continue

Despite substantial deficit reduction, DBRS highlights that Madrid’s overall budgetary performance remains in line with other Spanish regional governments. Deficit reduction has been a common trend among Spanish regions since 2015. In 2018, the average deficit of Spanish regions was -0.23% of GDP, with seven regions out of 17 outperforming Madrid’s fiscal results for the year.

In 2019, regional economic growth around 2.8% should remain supportive of the fiscal position. At the end of June 2019, DBRS positively notes that Madrid’s budgetary execution remained in line with 2018 performance. Nevertheless, Madrid, together with other autonomous communities, have so far not received the additional transfers from the regional financing system (revised 2019 entregas a cuenta), corresponding to approximately EUR 0.73 billion for Madrid, or 0.3% of regional GDP.

This situation reflects the absence of a fully functioning national government, with new Parliamentary elections now expected on 10 November 2019. As a result, should the region fail to receive these funds by the end of the year, DBRS considers that Madrid could miss the regional deficit target of -0.1%. DBRS, however, considers that any failure to meet the fiscal target related to one-off revenue shortfalls, will be temporary. It is therefore unlikely to challenge the encouraging fiscal consolidation path recorded in recent years.

The recent delay for regions in receiving additional transfers from the national government highlights, in DBRS’s view, the need for a reform of the regional financing system. DBRS considers that regions’ fiscal consolidation pace is directly affected by the level of taxes redistributed by the national government. Going forward, any revision of this financing system will be monitored as it is likely to have relevant credit implications for Madrid as well as other Spanish regions.

High Debt-to-Revenue Ratio but Risks are Mitigated by Sound Debt Structure

The rapid increase in the region’s debt over the past decade continues to be a negative credit feature for the region. Even if the debt to operating revenue ratio has gradually declined since its 2015 level, Madrid’s debt (DBRS’s adjusted debt figure) represented 197.4% of its operating revenues at the end of 2018, a high level in a national and international context. DBRS expects Madrid’s debt sustainability position to remain strong going forward given its wide economic base, but debt reduction will remain key for the region to strengthen its credit profile further.

Madrid’s debt structure, on the other hand, is sound, with a smooth amortisation profile of 7.37 years average maturity at the end of 2018, affordable debt costs at 2.21% of the debt stock, and a continued access to the bond market since the financial crisis. In DBRS’s view, bank loans and bond financing, including sustainable bonds, as well as a very limited recourse to the national government’s financing facilities that represent 4% of Madrid’s debt stock as of Q1 2019, underpin the region’s diversified financing sources. On the liquidity side, the central government’s financing facilities are viewed as potential backstop facilities, which reduce Spanish regions’ refinancing risks.

DBRS continues to consider that a strengthening of Madrid’s liquidity profile would represent a positive credit development, as it would allow the region to weather potential exogeneous shocks more appropriately. In that context, DBRS points out that at the end of June 2019, the region’s commercial debt grew 60% year-on-year, although from a very low level, to EUR 0.7 billion, while its average delay to supplier payments increased from 22 to 31.5 days. While DBRS considers that this deterioration largely reflects the delays related to the transfers of the 2019 entregas a cuenta, it will monitor the evolution of these metrics to assess for any negative credit implication.

RATING COMMITTEE SUMMARY

The DBRS European Sub-Sovereign Scorecard generates a result in the A (high) – A (low) range. The main points discussed during the Rating Committee include: the relationship between the central government and the Autonomous Community of Madrid, the region’s fiscal results, the regional financing system, Madrid’s debt metrics and debt structure, Madrid’s economic performance.

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.dbrs.com/research/350580/

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 applicable methodology is Rating European Sub-Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include the Autonomous Community of Madrid, Bank of Spain, Independent Authority for Fiscal Responsibility (AIReF), Instituto Nacional de Estatística (INE). DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS 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’s outlooks and ratings are under regular surveillance.

For further information on DBRS 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.

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Nicolas Fintzel, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer Global Financial Institutions and Sovereign Ratings Group
Initial Rating Date: February 1, 2019
Last Rating Date: March 29, 2019

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