DBRS Morningstar Upgrades Autonomous Region of Madeira to BBB (low), Trend Changed to Stable

DBRS Ratings GmbH (DBRS Morningstar) upgraded the Long-Term Issuer Rating of the Autonomous Region of Madeira (Madeira) to BBB (low) from BB (high) and Madeira's Short-Term Issuer Rating to R-2 (low) from R-4. At the same time DBRS Morningstar changed the trend on all ratings to Stable from Positive.

KEY CREDIT RATING CONSIDERATIONS
The upgrade of Madeira's ratings primarily reflects the ongoing rebalancing of Madeira's fiscal performance. The mid-year 2023 budgetary execution confirms the commitment of the region to structurally strengthen its fiscal performance through expenditure control. The improvement of the budgetary performance is supported by growing revenues, thanks notably to the extremely strong performance of the regional tourism sector. The upgrade is also underpinned by the upgrade of the Republic of Portugal ("A", Stable) on 21 July 2023. The Portuguese central government strongly supports the region, especially through guarantees on its long-term funding, as granted again in 2023 on a EUR 275 million bond issuance and a EUR 25 million loan. At year-end 2022, 82% of Madeira's direct debt was either guaranteed or directly held by the Portuguese central government.

The Stable trend reflects DBRS Morningstar's assessment that the risks to Madeira's ratings are now broadly balanced. The strong performance of the hospitality sector since 2022 has translated into higher tax revenues which should support the region's ongoing fiscal consolidation path. The strengthening of the region’s debt management in the last years should also mitigate interest rate risk in the near term. The region’s direct debt exposure to variables rates has been reduced to 43% at year-end 2022 from 75% at year-end 2019. However, given the very high debt level of the region, a continuous rise of interest rates could be a source of pressure on the region's fiscal performance.

CREDIT RATING DRIVERS
Madeira's ratings could be upgraded if any or a combination of the following occur: (1) Madeira is able to accelerate its deleveraging path; (2) Madeira’s economic outlook outperforms current expectations and the region enhances its economic resilience and diversification; (3) there are indications of a further strengthening of the relationship between the region and the central government; or (4) the Portuguese sovereign rating is upgraded.

Madeira's 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 to new debt accumulation; (2) indications emerge that the financial support and oversight currently provided by the central government weaken; or (3) the Portuguese sovereign rating is downgraded.

CREDIT RATING RATIONALE
Expenditure Control and the Extremely Strong Momentum of the Tourism Sector Support Madeira’s Ongoing Fiscal Consolidation

The region continues to benefit from the extremely strong momentum of its hospitality sector. Between January and May 2023, overnight stays were 23% above their 2019 level, versus 13% in Portugal. In 2022, overnight stays and revenues from tourism accommodation were already respectively 12% and 30% above their 2019 levels. This contributes to the good performance of the regional economy and its labor market with an unemployment rate at 6.5% in Q1 2023, which is now standing slightly below the national unemployment rate of 7.2%, versus 11.4% on average during 2015-2019.

In this very favorable economic context, Madeira improved its fiscal 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 0.8% of its operating revenues, versus operating deficits accounting for 17.3% of its revenues in 2021 and 8.5% in 2020. Similarly, the financing deficit decreased to 9.7% of operating revenues in 2022, from 24.9% in 2021 and 14.2% in 2020. Based upon the favorable mid-year 2023 budgetary execution, the region is likely to be able to record a low financing deficit or even a financing surplus this year. Given its very high debt burden, the ability of the region to structurally rebalance its fiscal performance is key and DBRS Morningstar will therefore pay particular attention to the fiscal strategy of the next regional government to be elected at the end of September 2023.

Madeira is Likely to Bring Back its debt-to-operating revenues ratio below 400% in 2023 but Debt Burden Remains Very High

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 reduce its debt-to-operating revenues ratio to a still very high 431% in 2022 versus 504% in 2020. The region is likely to bring back its debt-to-operating revenues ratio below 400% in 2023.

Thanks to its active debt management strategy, the region has been able to reduce the cost of its debt between 2017 and 2021. At year-end 2022, with the rising interest rate environment, the average interest rate of the region's direct debt slightly increased but remain relatively low at 2% versus 1.6% at year-end 2021. 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 2023, 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 region is currently working on strengthening its budgetary forecasting and budgetary execution tools. 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 (July 4, 2023) https://www.dbrsmorningstar.com/research/416784/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 – BB (high) range. The main points discussed during the Rating Committee include the regional economy’s situation and the Madeira’s financial performance, 2023 budgetary execution, 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/417483/portugal-republic-of-scorecard-indicators-and-building-block-assessments.

Notes:
All figures are in Euros unless otherwise noted.

The principal methodology is 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/416784/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 Region of Madeira for the 2017-2022 financial statements, 2023 monthly budgetary execution, debt and liquidity situation, 2023 budget, 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 credit 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 credit 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://registers.esma.europa.eu/cerep-publication/. 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 credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/417843.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Mehdi Fadli, Senior Vice President, Sovereign Credit Ratings
Rating Committee Chair: Nichola James, Managing Director, Sovereign Credit Ratings
Initial Rating Date: June 15, 2018
Last Rating Date: February 3, 2023

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