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

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Autonomous Community of Madrid’s Long-Term Foreign and Local Currency – Issuer Ratings at A. At the same time, DBRS Morningstar confirmed the Autonomous Community of Madrid’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS
Madrid's ratings are underpinned by (1) the region's large and diversified economy; (2) its strong fiscal results since 2018, which DBRS Morningstar expect to continue; (3) its sound debt structure and continued access to financial markets and (4) its strengthened liquidity profile. Despite the uncertainties related to remaining inflationary pressures, DBRS Morningstar anticipates that the region will be able to control debt accumulation in the next years thanks to its monitoring of expenditure and higher tax revenues, while extraordinary transfers from the central government related to the COVID-19 pandemic have phased out.

The Stable trends reflect DBRS Morningstar assessment that the risks to Madrid's ratings are currently balanced. Although remaining inflationary pressures and higher interest rates weigh on the economic outlook, the region's strong economic fundamentals and tax base, its fiscal flexibility, and strong financial management offset these challenges. Despite a deterioration of its fiscal performance in 2022, DBRS Morningstar takes the view that the region will bring back its deficit to a moderate level from 2023. In addition, DBRS Morningstar views positively the potential return of the Budget Stability Law, possibly in 2024, which should encourage the region to maintain a balanced budget.

RATING DRIVERS
The ratings could be upgraded if both the region maintains strong financial fundamentals, and the Kingdom of Spain's ratings are upgraded. 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 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 operational fiscal deficits to widen over time; (2) there is a marked and lasting deterioration in Madrid’s debt metrics, including wider and costlier annual maturities and higher leverage; or (3) the Kingdom of Spain's ratings are downgraded.

RATING RATIONALE

Fiscal Performance Deteriorated in 2022 due to Lower Revenues but Should Improve From 2023

In 2022, budgetary performance deteriorated with a result in national accounting standards' financing deficit estimated at 0.7% of GDP according to the National Independent Authority for Fiscal Responsibility (AIReF), versus a surplus of 0.3% of GDP in 2021. The deterioration stemmed from lower revenue, and resulted in the region widening its operating deficit to EUR 0.3 billion in 2022 from an operating surplus of EUR 1.3 billion in 2021. Capital expenditure net of capital revenues was EUR 0.4 billion in 2022, widening the financing deficit to EUR 0.7 billion from a financing surplus of EUR 0.8 billion in 2021.

DBRS Morningstar takes the view that some exceptional factors affected the 2022 fiscal performance but that structurally the financial performance has not deteriorated. Additionally the likely return of full capabilities of the Budget Sustainability Law (BSL) from 2024 would further strengthen the fiscal management after the lift of the general escape clause at the European Union (EU) level. For 2023, DBRS Morningstar expects an increase in revenues based on positive effects of the national financing system and from moderate economic performance. AIReF has estimated in its "Report on Initial 2023 budget" for Madrid a deficit at 0.1% of GDP this year, lower than Madrid's expectation on its initial budget at 0.3% of GDP. For 2023, the Spanish regional sector's performance will match the reference set at 0.3% of GDP deficit, according to AIReF.

However fiscal challenges will remain significant in 2023, with the implementation of transformative reforms underpinned by EU funds. Nonetheless, the related projected investments are under current tight expenditure pressure as a result of higher and longer-than-expected inflationary momentum. Moreover, the recent financial and health crises, coupled with the effects of the conflict in Ukraine, have caused debt growth and the deficit has grown. On the other hand, the energy price shock seems to have eased and generally higher interest expenditures will have a moderate immediate impact, provided that the prudential debt management exercised at the regional government level remains, and its continued access to financial markets (please see: Spanish Autonomous Communities' Access to State Funding Mechanisms Reduces Interest and Refinancing Risks, https://www.dbrsmorningstar.com/research/412232).

DBRS Morningstar views positively the fiscal improvement recorded by the region in recent years , but continues to take the view that maintaining this strong performance will remain challenging. Under this scenario, strong financial governance will be key to maintain a balanced budget and the likely reimplementation of the budget stability norms by the central government from 2024 should also contribute to fiscal sustainability. Despite Madrid being one of the only regions that has not been able to approve its 2023 budget, DBRS Morningstar takes the view that this will likely not be repeated after the absolute majority result of the May 2023 regional elections (please see: Madrid: Local and Regional Elections Point to Policy Continuity Re-Election of Madrid's Regional President and City Mayor, https://www.dbrsmorningstar.com/research/414624).

Economic Recovery Continues, with GDP Over Pre-Pandemic Levels, But Uncertainties Remain Given Remaining Inflationary Pressures and Increased Financing Costs

In terms of economic growth, AIREF estimates Madrid's 2022 real GDP growth at 5.9%, better than the national growth of 5.5%. This is partly explained by the continuation of a relatively stronger performance of Madrid already in 2021, with Madrid's GDP increasing by 5.4% according to the region's estimates, driven by a strong rebound in the construction and services sectors. Supported by the growth of its industry and services sector, Madrid’s GDP as of March 2023, was 2.2% over 2019 GDP according to the forecasts from the National Institute of Statistics. As of 2022, Madrid's unemployment rate was close to 11.2%, still below the national average of 12.9%.

The regional economy is expected to continue growing in coming years, broadly in line with the national average. DBRS Morningstar expects a continuation of strong tourism performance and robust job market performance to support Spain's GDP, but remaining inflationary pressures, increasing financing costs, and a weaker external backdrop are likely to somewhat weigh on growth in 2023. The European Commission (EC) revised its growth projections for Spain upwards to 1.9% in 2023 and forecast 2.0% growth in 2024 in its Spring 2023 economic forecast, from 1.4% for 2023. These forecasts remain clouded by inflation and the tightening monetary policy leading to a reduction in consumption and investment. On the other hand, the implementation of Next Generation EU (NGEU) investments should partially mitigate those input reductions. In addition, the energy price hikes seem to have eased, which should help mitigate the impact of inflation in the economy even though core inflation remains elevated. The persistence of high inflation rates increases the second-round effects on compensation of employees and business margins.

The financial resources expected from the 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 economic growth. The region estimates that revenues related to these EU funds amounted to around EUR 1 billion in 2022 and EUR 0.9 billion was already utilised. 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.

Despite A Slight Deterioration of its Debt Metrics, Madrid’s Debt Sustainability Remains Strong Supported by Diversification of Funding Sources and Continued Access to Financial Markets

DBRS Morningstar continues to foresee Madrid’s debt sustainability position as strong. With a debt ratio of 13.5% of regional GDP at end of 2022, the region’s debt remains substantially below the average for Spanish regions of 23.9%. Due to lower operating revenues, its debt-to-operating revenues ratio increased last year to 176% in 2022 versus 156% in 2021, given the lower extraordinary funds factored into operating revenue. This ratio remains high, but it represents a marked decrease from the 220% recorded at the end of 2015. The DBRS Morningstar-adjusted debt fact includes direct, indirect and guaranteed debt of the region, and also commercial debt, which does not consolidate in ESA (European System of Accounts).

Madrid has also substantially extended its average maturities through long-term issuances, bank loans and private placements since 2016 with maturities up to 50 years. The region is keeping this debt strategy as demonstrated in its 2022 debt operations with maturities generally between 5 and 20 years. Most recent data on the weighted average maturities of regional debt at end-2022 stood at 8.39 years, compared with 5.34 years recorded at the end of 2012. Unlike most of its national peers, the region has maintained consistent access to the financial markets since the financial crisis. As a result, at the end of 2022, Madrid’s bond issuances represented 58% of its debt stock or EUR 20.2 billion (Banco de España data), and 45% of the total bonds outstanding for all Spanish regions. Additionally, the region is committed to cover part of its funding needs through sustainable bond schemes, with the last issuance at February 2023 for an amount of EUR 1 billion. In DBRS Morningstar's view, bank loans and bond financing, including sustainable and green bonds, underpin the region's widely diversified financing sources.

Madrid has historically recorded a relatively low cash position, reflecting the region's efforts to maintain a cost-efficient liquidity profile. However, DBRS Morningstar takes the view that the set-up and successful launch of a Pagarés (commercial paper) programme in 2020 by Madrid, and the extension in 2022 of the size of the credit lines available to the region to EUR 1.8 billion, summing up to EUR 2.8 billion the region's liquidity toolkit, have overall strengthened its liquidity profile. The CP program also allows the region to minimize its interest cost, as it was able to issue CPs at negative interest rates in recent years and currently is an alternative for the use of credit lines depending on their cost. Going forward, DBRS Morningstar will continue to monitor the use of those liquidity instruments to assess their impact, if any, on the region's liquidity profile.

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 Autonomous Community of Madrid.

There were no Environmental or Governance 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 (May 17, 2022) 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 (low) – A range.

The main points discussed during the Rating Committee included DBRS Morningstar’s view that the Autonomous Community of Madrid’s result on recent elections points to fiscal policy continuity, economic growth prospects and the impact of the inflationary environment, Madrid’s public finances, the region’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/415602.

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.

DBRS Morningstar notes that this press release was amended on 6 July 2023 to incorporate the correct name of the DBRS Morningstar legal entity.

Notes:
All figures are in 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 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The sources of information used for this rating include the Autonomous Community of Madrid for financial and budgetary position and debt structure from 2016 to 2022, Madrid’s Investor Presentation, Bank of Spain for the debt stock during the period between 2016 and 2022, Independent Authority for Fiscal Responsibility (AIREF) for its April 2023 Individual Report on the Initial Budget of Autonomous Community of Madrid, the January 2023 monitoring of the 2022 budget stability targets and for its October 2022 report on Madrid’s 2023 budget considerations, Instituto Nacional de Estadistica (INE), Ministry of Finance, Ministry of Tax, General State Comptroller (IGAE), and 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. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/416014.

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

Lead Analyst: Jorge Espinosa, Assistant 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: February 24, 2023

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