DBRS Morningstar Changes Trend on Madeira to Positive, Confirms at BB (high)

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 trends on all ratings have been changed to Positive from Stable.

KEY RATING CONSIDERATIONS

The Positive trends are underpinned by the upgrade of the Republic of Portugal (A (low), Stable) on 26 August 2022 and reflect DBRS Morningstar’s view that that the region is likely to start deleveraging in the near term. This deleveraging relates to the rebalancing of Madeira’s fiscal performance, which was adversely impacted by the economic impact of the Coronavirus Disease (COVID-19) pandemic. This stronger fiscal performance benefits from the region’s tight grip over expenditure but also growing revenues thanks to the improvement in the regional economic prospects, especially the very favorable momentum for the hospitability sector. The economic outlook remains, nevertheless, clouded with uncertainties related to inflationary pressures, particularly higher energy prices. The region's capacity to execute projects funded by European Union (EU, AAA, Stable) programmes should also support Madeira's economic recovery. The Positive trends also reflect the continuous strengthening of the region’s debt management.

Madeira’s ratings remain underpinned by (1) the region’s track record of improving its debt metrics prior to the COVID-19 pandemic and its strong willingness to revert back to a deleveraging trend; (2) the financial oversight and support to the regional government from the Republic of Portugal; and (3) Madeira’s implementation of public finance reforms including the development of budgetary forecasting models.

RATING DRIVERS

Madeira’s ratings are likely to be upgraded if the region continues to demonstrate a strong commitment to deleveraging through 2022 and in its upcoming annual budgets. Madeira's ratings could also be upgraded if any or a combination of the following occur: (1) Madeira’s economic outlook outperforms current expectations and the region enhances its economic resilience and diversification; (2) there are indications of a further strengthening of the relationship between the region and the central government; or (3) the Portuguese sovereign rating is upgraded again.

The Positive trends on the ratings could return to Stable if Madeira's fiscal performance does not improve as strongly as expected, limiting the pace and volume of deleveraging. 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 Is Under Way, Supported by the Very Favorable Momentum for the Hospitality Sector in the First Half of 2022, but Uncertainties Remain Given Inflationary Pressures in Europe

The recovery in tourism is under way, especially since spring 2021, supported by the efficient handling of the healthcare situation by Madeira's authorities. The positive momentum in the hospitality sector was confirmed in the first half of 2022, surpassing the hospitality activity of the first half of 2019. Overnight stays in H1 2022 accounted for 107% of their H1 2019 level and revenues from tourism accommodation in H1 2022 reached 120% of their H1 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 2.3%, supported by the tourism sector with overnight stays increasing by 4.4% over the same period. 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 and reaching 7.3% in Q2 2022.

Going forward, the region's tourism sector will remain exposed to uncertainties related to inflationary pressures and 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 86 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 Improve from this Year

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 strongly reduce its deficits from 2022 onwards, thanks to its tight grip over expenditure and growing revenues, thanks to the recovery of the regional economy supported by the good results in the hospitality sector. 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 pre-funded its COVID-19 related measures in 2020 through a EUR 458 million loan and was therefore able to slightly decrease its DBRS Morningstar's adjusted debt stock in 2021. With the rise in operating revenues last year, the region was able to bring back its debt-to-operating revenues ratio to 484% versus 504% in 2020. The region's solid GDP growth and the parallel rise in tax proceeds prior to 2020 supported the decrease in Madeira's debt ratios and Madeira would have been able to maintain this trend if not for the impact of COVID-19. Nevertheless, from an international comparison, the region’s debt-to-operating revenues remains extremely high. 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 region’s 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 again in 2022, 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 the central government's support to the region is weaker than currently foreseen, would be credit negative for Madeira.

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 Republic of Portugal’s ratings are passed-through to Madeira.

Governance (G) Factors

The Institutional Strength, Governance and Transparency factor affects the ratings. 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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

RATING COMMITTEE SUMMARY

DBRS Morningstar’s European Sub-Sovereign Scorecard generates a result in the BBB (low) – BB 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/401837/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 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. Other applicable methodologies include 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 (May 17, 2022).

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.

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/402312.

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: March 04, 2022

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