DBRS Morningstar Confirms the City of Madrid at “A”, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Long-Term Issuer Rating of the City of Madrid (Madrid) at "A" and the Short-Term Issuer Rating at R-1 (low). The trend on all ratings remains Stable.

KEY RATING CONSIDERATIONS

Madrid's ratings are underpinned by (1) Spain's capital city's large and diversified economy; (2) Madrid's very strong financial performance over the last decade and the city's sound medium-term fiscal outlook; and (3) the significant improvement in Madrid's debt metrics to a relatively low level and its effective public sector debt management strategy. DBRS Morningstar also views positively Madrid's institutional environment, including a rather predictable and well calibrated financing framework for Spanish municipalities. Madrid's ratings also benefit from DBRS Morningstar's assessment of a high likelihood of support stemming from the Kingdom of Spain (A, Stable). DBRS Morningstar takes the view that despite its intrinsic strengths, the city of 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 Stable trend reflects DBRS Morningstar's view that risks to the ratings are currently balanced. The economic outlook remains clouded with uncertainties to inflationary pressures and the complete resolution of the healthcare situation. Although Madrid, thanks to its very strong financial position, has so far weathered the economic and financial impacts of the Coronavirus Disease (COVID-19) pandemic well, DBRS Morningstar will monitor the speed of full economic recovery and the potential negative economic and budgetary consequences of the current inflationary environment. Higher inflation, particularly on the energy front, is likely to linger. Its potential impact on Madrid's budgetary expenditure will remain key areas of focus going forward. These challenges are compensated for by the city's very strong economic and tax bases, its fiscal flexibility and Madrid's strong financial management track record.

RATING DRIVERS

The ratings could be upgraded if the Kingdom of Spain's ratings were upgraded.

The ratings could be downgraded if any or a combination of the following occur: (1) the Kingdom of Spain's ratings were downgraded; (2) although currently unlikely given its intrinsic strengths, a structural weakening in the city's fiscal performance, leading to fiscal deficits widening and a sustained and material rise in public sector debt.

RATING RATIONALE

The Economic Recovery Is Under Way but Uncertainties Remain Given Inflationary Pressures in Europe

The COVID-19 outbreak significantly affected the economies of Madrid and Spain in 2020. The region of 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, Madrid's GDP rebounded by 6.5%, according to the region’s estimates, outperforming the 5.1% for Spain's output, driven by a strong rebound in the construction and services sectors. The local and regional economies are 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 afterwards. Amid this background, the European Commission revised its forecast for Spanish growth to 4.0% in 2022 and 2.1% in 2023.

Despite the strength of the COVID-19 shock, the supportive measures taken by the national government during the pandemic 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 on the local and regional economy and support the recovery. 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 Q2 2022, the region of Madrid's unemployment rate had largely recovered its pre-pandemic level, standing at 10.2% 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.

Madrid Benefits From a Strong Financial Performance with Ample Fiscal Space

On the fiscal front, the city of Madrid benefits from a very strong track record of fiscal consolidation over the last decade. Madrid recorded a very sound budgetary performance, including significant recurring surpluses, which allowed it to markedly strengthen its financials and build up significant fiscal space. Between 2015 and 2019, Madrid's financing surplus averaged 22% of its operating revenues, an outstanding performance. COVID-19 primarily affected Madrid's revenues but the fiscal outturns remained strong throughout the pandemic. Although impacted by the decline in economic activity, Madrid's tax receipts remained solid in 2020, reflecting their relatively low correlation to the economic cycle, being mostly based on property taxes which tend to remain stable over time. Madrid also implemented countercyclical tax reductions throughout the pandemic, aiming to support households' purchasing power, and the city benefited in 2020 and 2021 from still high ordinary transfers (entregas a cuenta) from the national government, which supported Madrid's overall financial performance. As a result, while Madrid's financing surplus declined compared to 2019, related to increasing operating and capital expenditures, it remained positive over the last two years, averaging 3.5% of operating revenues.

For 2022 and 2023, DBRS Morningstar continues to take the view that the fiscal outlook for the city of Madrid remains sound. This was confirmed in the latest forecasts from the Independent Authority for Fiscal Responsibility (AIReF) for local governments published in July 2022 which estimate that Madrid's fiscal surplus under national accounting standards could reach EUR 380 million in 2022 compared with EUR 71 million in 2021. Nevertheless, downside risks, particularly related to the rise in inflation could heighten pressures on the city's expenditure, in particular its personnel costs. Effectively controlling operating expenses will remain critical to maintain the very strong fiscal performance over the medium-term. DBRS Morningstar also expects a higher level of capital expenditure in coming years, recovering from a lower level of investment in the years prior to the pandemic and supported by European funds and possibly the recourse to new debt. The city solicited financing under the NGEU programme of approximately EUR 200 million at the end of 2021, primarily focused on developing low carbon emission zones on its territory as well as sustainable urban transport. Going forward, additional financing requests will materialise to finance the implementation of the city's Recovery, Transformation and Resilience plan. Finally, while the uncertainty surrounding the tax on capital gains for real estate transactions (plusvalía municipal) generated at the end of 2021 remains, the impact for municipal finances has so far been manageable. This will however remain a point of focus for DBRS Morningstar going forward. Overall, despite the challenges, DBRS Morningstar considers Madrid's fiscal performance and outlook as strong, supported by the track record and still considerable fiscal space.

Madrid’s Debt Sustainability is Very Strong, Supported by Sound Debt and Liquidity Management

Madrid’s debt sustainability is very strong. It benefits from a low public sector debt position at the end of 2021, representing 33% of its operating revenues (Banco de España, "BdE" perimeter) or 38% when considering DBRS Morningstar-adjusted debt metrics, which include outstanding commercial debt. Madrid debt stock decreased very markedly over the last decade. Between the end of 2012 and the end of 2021, Madrid's debt (BdE perimeter) was reduced by 78% from EUR 7.7 billion to EUR 1.7 billion. DBRS Morningstar views positively the very strong debt reduction steadily implemented by the municipality, as it allowed Madrid to rebuild significant public finances headroom. Going forward, DBRS Morningstar foresees Madrid's debt ratio to marginally increase but remain moderate at around 40-45% of operating revenues before stabilising, reflecting the a possible inclusion of a remaining loan related to Madrid Calle 30, and a higher level of capital expenditure possibly financed in part through debt.

Madrid's liquidity and debt management is also strong. The city maintains diversified funding sources through bank loans with a wide range of institutions and debt issuances. At the end of 2021, the city had EUR 500 million in two bond issuances, or about 30% of its debt stock (BdE perimeter). It also maintains a relatively long average life on its debt, at 6.8 years at the end of 2021, with a smooth amortisation profile and more than 80% at fixed rates. Finally, the liquidity position is deemed strong, and Madrid maintains flexibility throughout the year with the addition when necessary of credit line facilities. DBRS Morningstar also takes the view that the central government’s financing facilities, although not currently used by Madrid to finance its capital expenditure programme, represent a potential financing backstop for the city.

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 the City of Madrid.

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 European Sub-Sovereign Governments Scorecard generates a result in the AA (high) – AA (low) range. Additional considerations factored into the Rating Committee decision included DBRS Morningstar’s view that the city of Madrid does not have the constitutional protection to be rated above the sovereign rating. In addition the Rating Committee considered the likely increase in the debt position of the city in the next two to three years, the remaining macroeconomic uncertainties and the risks to the fiscal outlook, particularly on the expenditure side.

The main points discussed during the Rating Committee include the city’s economic growth prospects and the impact of the inflationary environment, Madrid’s public finances, the city’s debt and liquidity profile, the likelihood of support from the national government, if ever needed.

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/402326/spain-kingdom-of-sensitivity-analysis-of-the-relevant-key-rating-assumptions

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 City 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. 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 City of Madrid for financial position for the 2015-20 period (Annual accounts for the 2015-20 period), monthly budgetary execution documents for 2020, 2021 and 2022, and debt structure documentation for the 2015-21 period, Bank of Spain for the debt stock during the period between 2015 and 2021 (Debt according to the excessive deficit procedure documents), Independent Authority for Fiscal Responsibility (AIReF) for its estimate of the 2022 local governments’ budgetary performance (Informe complementario de evaluación individual sobre la ejecución presupuestaria, deuda pública y regla de gasto 2022 de la corporaciones locales, July 2022), Instituto Nacional de Estadística (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.

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/402558

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: Thomas R. Torgerson, Managing Director, Co-Head Global Sovereign Ratings
Initial Rating Date: April 22, 2022
Last Rating Date: April 22, 2022

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