DBRS Morningstar Confirms the Autonomous Community of Madrid A (low), Trend Changed to Stable

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). Simultaneously, DBRS Morningstar changed the trend on Madrid's Long-Term Issuer Rating to Stable from Positive while the trend on the Short-Term Issuer Rating remains Stable.

DEVIATION FROM DBRS MORNINGSTAR’S EU CALENDAR

This is a deviation from DBRS Morningstar’s EU Sovereign, Sub-Sovereign, and Supranational Calendar due to new information becoming available on the creditworthiness of the issuer related to the Coronavirus Disease (COVID-19). DBRS Morningstar believes that this new information makes it inappropriate to wait until the next scheduled review of the issuer on 11 September 2020. The credit rating considerations and rationale are presented below.

KEY RATING CONSIDERATIONS

The trend change on the region's rating primarily reflects the trend change to Stable from Positive on the Kingdom of Spain's Long-Term Foreign and Local Currency – Issuer Rating of "A" on 29 May 2020. Spain's ratings trend change reflected DBRS Morningstar’s view that the country's good economic performance and steady fiscal consolidation have been reversed, at least in the near term, by the Coronavirus Disease (COVID-19) outbreak. Spain's output is now expected to fall sharply in 2020 and recover only partially in 2021.

Given the economic and financial linkages between the national and regional governments, Spain’s trend change affects DBRS Morningstar’s analysis of Madrid’s creditworthiness and underpins the trend change to Stable on its rating. Madrid's finances will be affected by a combination of higher healthcare-related expenditure and lower tax collection. Although DBRS Morningstar expects the national government to mitigate the impact on the region's financial performance in 2020, Madrid's fiscal outcomes are likely to remain under pressure in the next two-to-three years.

Madrid´s ratings remain underpinned by (1) the region’s large and diversified economy; (2) Madrid’s track record of an improving fiscal performance between 2015 and 2019; and (3) the region’s sound debt structure and continued access to the bond market. DBRS Morningstar continues to view 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

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

The rating could be downgraded if any or a combination of the following occur (1) the Kingdom of Spain is downgraded; (2) there is a structural reversal in the region’s fiscal consolidation, leading to fiscal deficits widening over time; or (3) there is a marked and lasting deterioration in Madrid’s debt metrics.

RATING RATIONALE

Madrid’s Economic Activity Will be Severely Affected by the COVID-19 Pandemic in 2020

Madrid’s economic size and performance remain key credit strengths for the region. Madrid represents 19% of Spain’s gross domestic product (GDP) and has consistently outperformed the national average on most economic indicators in recent years. Madrid has for instance a markedly higher GDP per capita than other Spanish regions, representing 136% of the national average. The region's labour market also started 2020 on a more favourable footing than some of its regional peers, with the unemployment rate at 10.0% compared with a national average of 13.8% at the end of 2019.

Nevertheless, COVID-19 is taking its toll on the Spanish and the regional economy. Madrid has been severely affected by the healthcare crisis. The region, in line with the rest of the country, has been under one of the longest and strictest lockdowns in Europe. This lockdown, aimed at slowing the transmission of the virus among the population has borne fruits, with the number of recorded cases recently dropping drastically. Nevertheless, the economic shock derived from this unprecedented lockdown will be very significant.

DBRS Morningstar considers that the fiscal measures announced by the central government to support the healthcare system –a responsibility of the Spanish regions– and to mitigate the long-term impact of the pandemic on the national economy should help alleviate the adverse consequences of the COVID-19 outbreak. However, a severe recession is now expected for 2020, with the national government forecasting the country's real GDP to decline by 9.2% before recovering partially with growth of 6.8% in 2021. While DBRS Morningstar expects this shock to affect all Spanish regions, its overall impact on the region of Madrid will depend in large part on how quickly economic activity normalises.

Pressures on The Region’s Fiscal Performance Will Increase, but the National Government Will Limit the Adverse Impact

On the fiscal front, Madrid has been a solid performer in recent years, with sound fiscal consolidation supported by strong annual economic growth of 3.4% on average since 2015. Madrid headline deficit therefore declined from -2.49% of regional GDP in 2011, to -0.27% in 2019. DBRS Morningstar moreover highlights that the 2019 figure was negatively affected by a one-off revenue shortfall related to lower VAT receipts, representing approximately 0.15% of regional GDP. Madrid therefore markedly outperformed the national average of a deficit of -0.55% of GDP that year, with only three regions out of seventeen releasing stronger results.

In 2020, further fiscal consolidation appears challenging given the rapid deterioration in economic indicators in the region and in Spain. DBRS Morningstar currently expects strong pressure on Spanish regions' operating expenditure, as regions directly manage healthcare related costs which are expected to increase. In addition, the anticipated drop in economic output in 2020 is likely to markedly affect regional taxes collected by the region.

On the other hand, Madrid and other Spanish regions under the common regime are likely to benefit from the automatic stabiliser built into the regional financing system. While the pandemic is likely to decrease substantially the level of taxes collected by the central government and in particular shared taxes such as value added tax and personal income tax, the regions should remain insulated from this in 2020. The government has indeed not revised down the level of transfers (entregas a cuenta) that it will make to regions this year. Transfers from the financing system will therefore continue to increase in 2020; by 7.3% year-on-year compared with 2019.

The negative effect of the lower tax collection in 2020 will therefore be borne by the central government. While this will support regions in 2020, the regional financing system will prompt a negative settlement to be paid by regions in 2022, which is likely to be very substantial. DBRS Morningstar considers however likely that the national government will allow regions to repay this settlement over the long-term, as it did regarding the 2008 and 2009 negative settlements which are currently being repaid over 20 years.

DBRS Morningstar also highlights that the national government recently approved additional fiscal transfers to its regions (Fondo No Reembolsable), totaling EUR 16 billion or 1.3% of national GDP for 2020. These correspond to one-off measures aimed at supporting regional finances on the face of the COVID-19 crisis. These funds will be split between EUR 10 billion directed to healthcare expenditure, EUR 5 billion to compensate for lower regional revenues and EUR 1 billion for additional social costs borne by regions. Overall, based on the Independent Authority for Fiscal Responsibility (AIReF), the additional deficit for all Spanish regions related to COVID-19 in 2020 is estimated between 1.2% and 1.7% of GDP. This additional deficit could therefore be in large part compensated by the extraordinary transfer from the national government of EUR 16 billion to the sector.

DBRS Morningstar therefore anticipates that Madrid and other Spanish regions' 2020 financial performance should be only partially affected by the COVID-19 crisis, as the central government finances take the hit. The situation is nevertheless likely to deteriorate rapidly in 2021 and 2022, with lower revenues from the regional financing system and still high expenditure increasing pressure on regional finances. While the national government is likely to continue supporting its regions, growing regional deficits and debt levels are likely to materialise.

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 2019, its debt-to-GDP ratio was 14.0%, one of the lowest amidst its national peers. Nevertheless, debt reduction remains key in DBRS Morningstar's view 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 7.7 years at the end of April 2020, affordable interest costs at 1.93 % of the debt stock, and continued access to the bond market.

In DBRS Morningstar’s view, bank loans and bond financing, including sustainable bonds and more recently a first green bond, as well as a very limited recourse to the national government’s financing facilities that represent 4% of Madrid’s debt stock as of year-end 2019, underpin the region’s widely 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 Morningstar 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 Morningstar points out that the region is launching in 2020 a commercial paper programme (programa de pagarés) sized at EUR 500 million and is planning on extending its credit lines, which should broaden its liquidity toolkit. The use of such programme and credit lines will be monitored to assess for any strengthening in Madrid's liquidity profile.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

RATING COMMITTEE SUMMARY

The DBRS Morningstar 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 and the potential impact of the COVID-19 on its fiscal and debt trajectories. The relationship between the national government and the Autonomous Community of Madrid was also discussed.

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/361814/.

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 Global Methodology for Rating European Sub-Sovereign Governments (6 September 2019): https://www.dbrsmorningstar.com/research/350151/rating-european-sub-sovereign-governments.

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.

The sources of information used for this rating include the Autonomous Community of Madrid for financial position and debt structure for the 2014-18 period, Bank of Spain for the debt metrics during the 2014-19 period, Independent Authority for Fiscal Responsibility (AIReF) for its Report on the Stability Programme Update 2020-2021, Instituto Nacional de Estatística (INE), Ministry of Finance for the monthly budgetary execution. 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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/362074.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. 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 13, 2020

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This press release was amended on 16 June 2020 to fix the publication date of the "Global Methodology for Rating European Sub-Sovereign Governments" methodology.