DBRS Morningstar Confirms City of Madrid at A, Stable Trend

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

KEY CREDIT RATING CONSIDERATIONS
Madrid's credit ratings are underpinned by (1) Spain's capital city's large and diversified economy; (2) its strong financial performance over the past 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. Madrid's credit ratings also benefit from DBRS Morningstar's assessment of a high likelihood of support from the Kingdom of Spain (rated "A" with a Stable trend by DBRS Morningstar). DBRS Morningstar takes the view that, despite its intrinsic strengths, the City of Madrid does not have the constitutional protection to its current revenue framework and it therefore does not qualify to be rated higher than the sovereign. Madrid's credit ratings are, therefore, capped by the Kingdom of Spain’s credit ratings.

The Stable trends reflect DBRS Morningstar's view that risks to the credit ratings are currently balanced. Although the construction of the 2024 budget faces headwinds such as remaining inflationary pressures and higher interest rates, the city's strong economic fundamentals and tax bases, its fiscal flexibility, and strong financial management track record offset, in our view, these challenges and the city is expected to keep its strong fiscal performance in the coming years.

CREDIT RATING DRIVERS
The credit ratings could be upgraded if the Kingdom of Spain's credit ratings were upgraded.

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

CREDIT RATING RATIONALE
Fiscal Performance Recovery is Under Way in 2023 And Confirms City’s Structurally Strong Fiscal Capacity

Madrid's financial performance deteriorated in 2022 to a deficit of 4.7% of operating revenues following a surplus of 4.0% in 2021. This deterioration stemmed from higher expenditures related to inflation and the city's higher capital expenditure net of capital revenues. At the same time, operating revenues decreased by 1.3% annually mainly due to the change in the calculation method of the tax on gains to municipal land and the negative settlement from the national funding system. The deterioration of the fiscal performance was common among large Spanish municipalities in 2022, with an average deficit of 1.4% of operating revenues, although lower than the City of Madrid's deficit. DBRS Morningstar takes the view that some exceptional factors affected the 2022 fiscal performance of Madrid but that, structurally, the city should be able to bring back its fiscal performance at stronger levels. Moreover, the central government will compensate in 2023 and 2024 a share of the revenues loss related to the 2020 negative settlement. This compensation should amount to EUR 211 million. Moreover, part of the lower 2022 operating revenues are expected to be one-shot as the city paid back in 2022 the tax proceeds collected in past years from the taxes on gains to municipal land following a legal decision.

DBRS Morningstar continues to view the fiscal outlook for the city as sound for 2023 and 2024. The Independent Authority for Fiscal Responsibility's (AIREF) expects a strong fiscal improvement starting in 2023 with a financing surplus of 1.8% of operating revenues followed by a very high surplus of 8.1% of operating revenues in 2024, which is higher than the expected average surplus for Spanish largest cities of 0.7% in 2023 and 4.5% in 2024. The fact that Madrid almost fully paid back the rebates on tax on municipal land in 2022 underpins the much stronger fiscal performance in 2023 and 2024 given that most of the sector peers will need to refund those tax rebates during these years. The fiscal performance improvement is already under way: up to September of 2023, the City of Madrid reported an operating surplus of around EUR 1.2 billion against an operating deficit of 260 million for the same period as of September 2022 (although these figures are not fully representative given that in general there is a concentration of expenditures in the late part of the year). Additionally AIREF report also considers that the expected return of full capabilities of the Budget Stability Law (BSL) from 2024 that would strengthen the fiscal management after the lift of the general escape clause at the European Union (EU) level.

The 2024 budget has been prepared during the Autumn and the information has already made public. The budget is expected to be approved before the end of the year. For 2024 there are fiscal challenges related with the lack of clarity on the new fiscal rules framework from the European authorities. The city's administration has budgeted 15% annual growth of personnel expenditure and also of the goods and services, especially those coming from outsourced services contract renewals which are impacted by inflation. On the revenue side, the city expects an 8% annual growth of operating revenues mainly supported by higher transfers from the central government which should allow the city to show a slight surplus in its budget. DBRS Morningstar expects the municipality to continue its fiscal policy of reducing rates on its own taxes progressively and that it will remain committed to sound fiscal performance over the medium term. The city has demonstrated strong fiscal discipline over the last years and the 2024 budget is expected to result in a slight surplus. In addition, DBRS Morningstar highlights that Madrid benefits from fiscal headroom and fiscal flexibility, which would allow the city to significantly increase its tax receipts by raising local tax rates if needed.

Slight Increase of the Debt in 2023 But Strong Liquidity And Debt Profile Remains as an Outstanding City’s Feature

The city’s debt has decreased rapidly over the last decade, with a more than fourfold decline in Madrid's debt stock to EUR 1.7 billion from EUR 7.7 billion between 2012 and 2022, with a marked improvement until 2018 and a slower but constant decrease in recent years. As of November 30, 2023, the city's debt increased to almost EUR 2.0 billion but is expected to decrease to EUR 1.9 billion by the end of the year. With a debt ratio of 41% of operating revenues at the end of 2022, the city’s debt remains substantially below the 75% limit set in the national government's Budgetary Law; surpassing this limit would prompt rebalancing measures to bring down local debt. In recent years, the city’s debt sustainability has significantly strengthened, reflecting a relatively low debt stock, wide economic and tax bases, and strong access to diversified financing sources.

The city's debt structure is sound, with limited short-term debt representing less than 1% of its debt stock at the end of 2022. The city is not exposed to any foreign-exchange risk as all of its debt stock is denominated in euros and its average cost of debt has improved to 2.74% as of November 30, 2023 from 3.06% as of December 31, 2022 and 4.65% as of December 31, 2021. Around 68% of its debt stock was at fixed rate as of November 30, 2023. Unlike the vast majority of other local governments in Spain, the city has also maintained a large share of its debt in the form of bond issuances. As of November 30, 2023, Madrid’s EUR 300 million bond issuances amounted 15% of its close to EUR 2.0 billion debt stock and around 80% of the total bonds outstanding for all Spanish local governments (excluding Spanish regions) in H1 2023.

As of November 30, 2023, the city's cash position was very favorable at EUR 1,095 million. The city's liquidity is deemed strong, reflecting the cash buffer from which Madrid benefits, which more than covers the city's debt redemptions over the next five years as well as its access to credit line facilities, when necessary. Additionally Madrid has started to received interest revenue from deposits that would help the city reduce further the net interest expenditure. DBRS Morningstar is confident that the city can meet its financing requirements, given its strong liquidity position and ultimately the backstop financing support from the national government. Moreover, the 2023 funds for local entities of EUR 1,350 million includes EUR 1,076 million designated to assist municipalities recurrently surpassing the average suppliers' payment target of 60 days (Madrid recorded 28 days at the end of September 2023). Nevertheless, despite that Madrid is unlikely to resort to this financing backstop it would be a good alternative if the liquidity of the city weaken over time.

Madrid’s Strong Economy as Capital of the Country Remains Underpinning the Economic Prospects

Madrid is the capital of and the most populated city in Spain, with a population of approximately 3.3 million inhabitants and a GDP estimated at around EUR 169 billion at the end of 2022. The city is located in the Autonomous Community of Madrid (rated "A" with a Stable trend by DBRS Morningstar), which benefits from the largest regional economy in Spain representing close to 20% of Spain’s GDP. Despite some economic differences with the Autonomous Community of Madrid, the city's economy represents a substantial share of the region, and is affected by the national economic context.

For 2022, Madrid's real GDP grew by 6.2%, better than Spain's growth rate of 5.8% and it is expected to grow by 2.7% in 2023 according to AIREF forecasts. This performance is consistent with what the region grew before it entered the crisis triggered by the pandemic, when it recorded an annual average real GDP growth of 3.5% between 2015 and 2019, above Spain's average of 2.8%. DBRS Morningstar expects a continuation of strong tourism performance and robust job market performance to support Spain's GDP, but increasing financing costs, and a weaker global economic growth momentum are likely to somewhat weigh on growth in 2023 and 2024.

The municipal economy is expected to continue growing broadly in line with the regional economy and consequently with the national average. The European Commission (EC) revised its growth projections for Spain upwards to 2.4% in 2023 and downwards in 2024 to 1.7% growth, in its Autumn 2023 economic forecast, from 2.2% for 2023, and 1.9% for 2024 at Summer. The downside risks relate to the prolonged impact on demand of the tightening financial conditions ,notably due to elevated external public and private debt. Although the increase in households purchasing power combined with the liquidity accumulated over the last years could partly mitigate the headwinds on consumption and investment.

In the region's housing market, the house price's index (based in 2015 prices) from Statistical National Institute (INE) keeps rising to 163 in H1 2023 from 156 in H1 2022, although its growth was disrupted for first time since 2020 in Q4 2022. At the same time, the number of transactions has decreased around 20% in H1 2023 from H1 2022, likely because of higher interest rates. This evolution is important for the city's fiscal performance, given its high share of revenues from real estate tax and tax on gains to municipal lands (unrealised until the sale of the property) which together total around 40% of municipal operating revenues.

The financial resources expected from the NGEU, including the Recovery and Resilience Facility (RRF) and REACT-EU funds, should continue to support reforms and investments. 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 spent. Going forward, the impact of 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 full economic impact. Additionally, Madrid is the largest recipient of foreign investment funds with almost 50% of the national's and this should positively influence the prospects of the regional economy.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Social (S) Factors

The Passed-through Social credit considerations have a relevant effect on the credit ratings, as the social factors affecting the Kingdom of Spain’s credit ratings are passed-through to City 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 (04 July 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 AA (high) – AA (low) range. The main points discussed during the Rating Committee included the City of Madrid’s fiscal performance and debt evolution in 2023, financial forecasts and the situation of the regional economy as a proxy of the municipal economy.

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/424856.

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 unless otherwise noted.

The principal methodology is the Rating European Sub-Sovereign Governments (11 August 2023) https://www.dbrsmorningstar.com/research/419048/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 these credit ratings include City of Madrid for financial position for the 2015-22 period (annual accounts for the 2015-22 period), annual budgetary execution documents for 2022, economic structure for 2023, and debt structure documentation for the 2016-22 period, Bank of Spain for the debt stock during the period between 2015 and 2022 (Debt according to the excessive deficit procedure documents), Independent Authority for Fiscal Responsibility (AIREF) for its estimate of the 2023 local governments’ budgetary performance (Informe complementario de evaluación individual sobre la ejecución presupuestaria, deuda pública y regla de gasto 2023 de la corporaciones locales, October 2023), for its Supplementary Individual Assessment Report on the 2023 Budgets of Local Governments (April, 2023) and for its economic and financial information observatory of Autonomous Communities, Instituto Nacional de Estadística (INE), Ministry of Finance; the Spring 2023 economic forecast from the European Commission, 2020 European Social Progress Index, Haver Analytics. 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/425390.

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

Lead Analyst: Jorge Espinosa, Assistant Vice President, Credit Ratings, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Credit Ratings, Global Sovereign Ratings
Initial Rating Date: July 06, 2018
Last Rating Date: June 16, 2023

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