DBRS Morningstar Confirms the Autonomous Region of the Madeira at BB (high), Trend Remains Positive

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 trend on all ratings remains Positive.

KEY RATING CONSIDERATIONS

Madeira’s ratings are underpinned by (1) the region’s strong willingness to continue to improve its fiscal performance and maintain its deleveraging path; (2) the financial oversight and support to the region from the Republic of Portugal (A (low), Stable); and (3) Madeira’s implementation of public finance reforms including the development of budgetary forecasting models.

The Positive trend continues to reflect the expected continued rebalancing of Madeira’s fiscal performance, which was adversely impacted by the economic impact of the Coronavirus Disease (COVID-19) pandemic. Madeira’s budgetary performance has improved in 2022, thanks notably to the estimated 12% growth of its operating revenues which notably benefited from the extremely strong performance of the regional tourism sector. The economic and fiscal outlook remains, nevertheless, clouded with uncertainties related to inflationary pressures and increasing interest rates. The Positive trend also reflects the continuous strengthening of the region’s debt management in the last years. The region’s direct debt exposure to variables rates has been reduced to 43% at year-end 2022 from 75% at year-end 2019 and the cost of debt has decreased. However, given the very high debt level of the region, continuous rise of interest rates would rapidly impact its budgetary performance.

RATING DRIVERS
Madeira's ratings could be upgraded if the region continues to improve its fiscal performance and keeps its deleveraging path. 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.

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 Extremely Strong Recovery of the Tourism Sector Supports the Growth of Regional Economy and the Improvement of the Region’s Fiscal Performance

The recovery in tourism was under way since spring 2021 supported by the efficient handling of the healthcare situation by Madeira's authorities. The very positive momentum in the hospitality sector continued at a fast pace last year. Overnight stays in 2022 accounted for almost 112% of their 2019 level, versus 99% nationally. Revenues from tourism accommodation between January and November in 2022 reached 129% of their 2019 level. This contributed to the good performance of the regional economy and its labor market with an unemployment rate standing at 6.2% in Q3 2022, close to the national unemployment rate of 5.8%, versus 11.4% on average during 2015-2019.

In this very favorable economic context, Madeira improved its budgetary performance in 2022, with its tax revenues growing by 16%. The region was able to post last year its first operating surplus since 2013 accounting for around 1% of estimated operating revenues, versus operating deficits accounting for 17.3% of its revenues in 2021 and 8.5% in 2020. Similarly, the estimated financing deficit decreased to around 10% of operating revenues in 2022, from 24.9% in 2021 and 14.2% in 2020. Madeira’s 2023 budget includes a financing deficit close to 10% of operating revenues versus 19% in the 2022 budget. Nevertheless, given the region’s very high debt level, this financing deficit remains at this stage insufficient to allow for a structural deleveraging. The medium-term debt trajectory of the region remains the key focus of DBRS Morningstar's analysis.

Decrease of Adjusted Debt Stock Continued at a Modest Pace in 2022, Thanks Notably to the Use of Cash, But Structural Deleveraging Remains a Challenge

The region pre-funded its COVID-19 related measures through a large EUR 458 million bond in 2020 and was therefore able to use its excess cash to fund its deficits in 2021 and 2022 and decrease its DBRS Morningstar's adjusted debt stock in the last two years. With the rise in operating revenues, especially in 2022, the region was able to bring back its estimated debt-to-operating revenues ratio to around 430% in 2022 versus 504% in 2020. Nevertheless, DBRS Morningstar considers that a structural deleveraging will be related to the capacity of the region to continue to improve its fiscal performance.

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. However, despite the reduction of its direct debt exposure to variables rates to 43% at year-end 2022 from 75% at year-end 2019, DBRS Morningstar considers its fiscal performance would be negatively affected by a continuous increase of interest rates given its very high debt level.

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). 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.

There were no Environmental factors that had a significant or relevant effect on the credit analysis.

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 (17 May 2022).

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’s recovery and Madeira’s financial performance, liquidity 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/408861/portugal-republic-of-scorecard-indicators-and-building-block-assessments.

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. In addition, DBRS Morningstar uses 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 (17 May 2022) in its consideration of ESG factors.

The sources of information used for this rating include the Autonomous Region of Madeira for the 2016-2021 financial statements, 2022 monthly budgetary execution, debt and liquidity situation, 2023 budget, Instituto Nacional de Estatística (INE) and 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/409294.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom

Lead Analyst: Mehdi Fadli, Senior Vice President, Senior Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head Global Sovereign Ratings
Initial Rating Date: June 15, 2018
Last Rating Date: September 02, 2022

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