DBRS Morningstar Confirms the Autonomous Community of Madrid at A (low), Trend Remains Positive

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Long-Term Issuer Rating of the Autonomous Community of Madrid (Madrid) at A (low) and maintained the Positive trend. 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 Positive trend on the Long-Term Rating continues to reflect DBRS Morningstar's view that (1) Madrid has delivered strong fiscal results in the last three years and is likely to continue doing so in the foreseeable future; (2) the region is strengthening its liquidity profile; and (3) downside risks related to the COVID-19 pandemic have receded. The economic outlook remains nevertheless clouded with uncertainties related to inflationary pressures and the complete resolution of the healthcare situation. So far, Madrid's finances have weathered well the shock of the COVID-19 pandemic, supported by the extraordinary financial transfers provided by the national government to all Spanish regions. Going forward, DBRS Morningstar's analysis will focus on the speed of the economic recovery as well as the region's effectiveness in controlling its expenditures as extraordinary national government support wanes.

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.

RATING DRIVERS

The ratings could be upgraded if any or a combination of the following occur: (1) Madrid delivers strong and recurring fiscal results; (2) the region places its debt on a medium-term downward trajectory and it continues to strengthen its liquidity profile; or (3) the Kingdom of Spain's ratings are upgraded.

The trend on the Long-Term Ratings could return to Stable if Madrid's fiscal performance deteriorates, leading to weaker fiscal and debt positions than currently expected. 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 deficits to widen over time; (2) there is a marked and lasting deterioration in Madrid’s debt metrics; or (3) the Kingdom of Spain's ratings are downgraded.

RATING RATIONALE

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

The COVID-19 outbreak significantly affected the Spanish and the regional economies in 2020. 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 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 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 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, 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 within the region's territory.

Madrid’s Fiscal Performance Strengthened Supported in Part by the National Government’s Financial Transfers

On the fiscal front, Madrid’s performance remained strong throughout 2021. The region is estimated to have delivered a small financial surplus of 0.32% of GDP, supported by the economic recovery and the extraordinary transfers from the national government. This corresponds to a marginal improvement from the slight surplus of 0.02% recorded in 2020 and the deficit of -0.26% of GDP in 2019. DBRS Morningstar views positively the fiscal improvement recorded by the region in the last three years, but continues to consider that maintaining this strong performance will remain challenging, as government extraordinary measures are wound down and inflationary pressures linger. DBRS Morningstar will monitor the potential pass through of inflation to structural regional expenditure, such as personnel and healthcare related costs, as this may negatively affect regional finances, particularly if coupled with an increase in financing costs and a slowdown in economic growth.

In 2022, the national government is maintaining a high level of transfers (entregas a cuenta) to its regions. These transfers within the regional financing system will also be complemented with extraordinary transfers of EUR 7.0 billion meant to compensate regions for a negative fiscal settlement related to 2020 and a VAT payment shortfall from 2017. While these additional funds will continue 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. As a result, addressing the share of new expenditure incurred during the pandemic, particularly healthcare related, that is likely to remain structurally higher, will remain critical for regions to maintain a sound budgetary position over the medium-term. Latest forecasts from AIReF points to a deficit of 0.9% of GDP for the Spanish regional tier this year, versus a reference rate set at 0.6% for 2022, due to higher expenditure incurred and lower revenues related to European funds. Latest forecasts from the Independent Authority for Fiscal Responsibility (AIReF) estimate that Madrid's deficit in 2022 could reach 0.5% of GDP, close to the region’s deficit estimate of 0.6%.

As a result, DBRS Morningstar's analysis of the region's fiscal and economic performance will continue to focus on (1) the level of national government's transfers to its regions; (2) the effectiveness of the regional government's control over structural expenditure; and (3) the speed of absorption of EU funds.

Madrid’s Debt Sustainability to Remain Strong, Liquidity Profile is Strengthening

DBRS Morningstar continues to expect Madrid’s debt sustainability position to remain strong in coming years, given the region's wide economic base. At the end of Q1 2022, its debt-to-GDP ratio was 14.6%, among the lowest of Spanish regions. While Madrid's adjusted debt-to-operating revenues ratio is estimated to have decreased to 156% at the end of 2021 from 186% at the end of 2019, it continues to reflect in part the increase in revenues due to the substantial rise in transfers received from the national government last year. From a debt stock point of view, Madrid's debt has remained relatively stable over the last three years, only increasing very marginally. As a result, DBRS Morningstar takes the view that stabilising and possibly improving debt metrics further, will remain an important step 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 8.06 years in June 2022, affordable interest costs at 1.92% 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.

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 in the region's credit line facilities. These provide the region with additional room to weather potential exogeneous shocks. The CP program also allows it to minimize its interest cost, as the region was able to issue CPs at negative interest rates. 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. 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.

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.

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 AA (low) – A range. Additional considerations factored into the Rating Committee decision included the high level of extraordinary transfers from the national government in 2020 and 2021 which inflated the region’s revenues in the last two years, therefore improving its financial metrics, the remaining macroeconomic uncertainties, the risks to the fiscal outlook, particularly on the expenditure side.

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.

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 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. 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 Autonomous Community of Madrid for financial position, budgetary execution and debt structure for the 2016-21 period, Madrid’s Investor Presentation, Bank of Spain for the debt stock during the period between 2016 and Q1 2022, Independent Authority for Fiscal Responsibility (AIReF) for its July 2022 report on the 2022 budgetary execution, Instituto Nacional de Estatística (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/402555.

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: February 1, 2019
Last Rating Date: March 11, 2022

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