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

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Long-Term Issuer Rating of the Autonomous Community of Madrid (Madrid) at “A”. At the same time, DBRS Morningstar confirmed Madrid's Short-Term Issuer Rating at R-1 (low). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
Madrid's credit ratings are underpinned by (1) the region's large and diversified economy; (2) its strong fiscal results since 2018, which DBRS Morningstar expects 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's strong management will be able to control the growth of expenditure and contain debt accumulation even if the economic prospects would be more limited than previously anticipated.

The Stable trends reflect DBRS Morningstar’s assessment that the risks to Madrid's credit 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 in 2023 and possibly reach budget balance in 2024. In addition, DBRS Morningstar views positively the potential return of the Budget Stability Law (BSL), possibly in 2024, which should further encourage the region to maintain a balanced budget.

CREDIT RATING DRIVERS
The credit ratings could be upgraded if both the region maintains strong financial fundamentals, and the Kingdom of Spain's credit ratings are upgraded. Madrid does not have the constitutional protection to be rated above the sovereign credit rating and its credit ratings are therefore capped by the Kingdom of Spain’s credit ratings.

The credit 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 operating 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 credit ratings are downgraded.

CREDIT RATING RATIONALE
Fiscal Performance Recovery is Under Way in 2023 And Fiscal Rules Will Contribute to Return To Robust Fiscal Results

In 2022, the budgetary performance deteriorated with a financing deficit of 0.7% of GDP under national accounting standards 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 revenues, 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. The 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.

Up to the end of October 2023, Madrid's operating revenues grew by 10% over the same period in 2022 and were above the 2021 level which was the record high mainly because it benefited that year from extraordinary state funding to alleviate the impacts of the pandemic. The region, which usually is very prudent on its forecasts, expects to finish 2023 with 8% revenues growth, which is a very strong performance given that in 2023 there are no exceptional revenues other than the European funds such as Mecanismo de Recuperación y Resiliencia (MRR) at EUR 668 million and REACT-EU at EUR 237 million. This favorable trend is expected to continue in 2024 as the regional financing system should settle the difference between the actual tax collection and the operating transfers received by the region in 2022. In 2022, inflation started to accelerate and the operating transfers granted to the Region were not adjusted, hence the expectation is for the settlement of the regional financing system to be significantly positive in 2024.

DBRS Morningstar takes the view that some exceptional factors affected the 2022 fiscal performance but that structurally the budgetary performance has not deteriorated. Additionally, the likely return of full capabilities of the BSL from 2024 would further strengthen the fiscal management after the lifting of the general escape clause at the European Union (EU) level. AIREF has worsened its deficit expectations for Madrid this year to a deficit of 0.4% of GDP from a 0.1% deficit in their previous report and it is above the reference deficit target set by the central government at 0.3%. The deterioration can be explained by higher expenditure stemming from the civil servants' wage rise (imposed by the central government) and lower-than-expected housing taxes given the lower real estate activity. However, Madrid's budget should support a fiscal improvement in 2024 given that the budget is balanced; and AIREF also expects Madrid to reach a balanced budget while for the regional sector the expectation is a 0.2% of GDP surplus. Nevertheless, Madrid's budget may allow for higher deficit if the central government reviews the deficit target.

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.

Economic Prospects Continue to Perform in Line With the Sovereign Helped by the EU Funds Implementation And Resilient Job Market Performance

For 2022, Madrid's real GDP grew by 6.2%, better than Spain's growth rate of 5.8%. After two years of strong growth following the recovery of the crisis triggered by the pandemic, AIREF expects for 2023 a more modest growth rate at 2.7%. However, 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%. The regional economy is expected to continue growing 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 increasing financing costs, and a weaker global economic growth momentum are likely to somewhat weigh on growth in 2023 and 2024.

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.

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 utilised. 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 strength of the recovery within the region. 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.

Madrid’s Debt Sustainability to Remain Strong Underpinned by Financial Markets Access And Potential Debt Relief May Further Decrease Debt Stock

DBRS Morningstar continues to foresee Madrid’s debt sustainability position as strong. With a debt ratio of 14.1% of regional GDP at end of 2022, the region’s debt remains substantially below the average for Spanish regions of 23.9%. AIREF expects the debt ratio to decrease to 13% in 2023 on its Report of budget results, public debt and expenditure benchmark of 2023 (July 2023). Moreover in 2024 it should keep decreasing to 12% according to AIREF and the decreasing trend is expected to be maintained over the medium term.

Moreover, the debt of Madrid could potentially decrease further in the medium term as a consequence of the recent political agreement between the centre-left Partido Socialista Obrero Español (PSOE) and the pro-independence Catalan party Esquerra Republicana de Catalunya (ERC) in order to gain enough support on the central government formation, which included reference to a debt relief that is expected to be extended to all the autonomous communities except for Basque Country and Navarre. Few details on the form, date and magnitude of these commitments is made available. Despite the uncertainty, DBRS Morningstar understands that it is likely that the central government would take over part of the debt accumulated by the autonomous communities since 2012 and considers that such a mechanism would likely improve the financial metrics of the regions, although the magnitude of this improvement is likely to vary from one region to the other. Regarding Madrid, given that it is already rated at the same level as the sovereign, we do not expect direct credit rating implications from a potential debt-relief mechanism.

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 very committed to maintain part of their funding needs covered by sustainable and green bond schemes, with the latest sustainable issuance in February 2023 for an amount of EUR 1 billion and the latest green issuance in June of 2023 for an amount of EUR 600 million. The sustainable bond schemes are issued to fund a combination of projects related with the social development or with environmental benefits, while the green bonds follow specifically the green bond principles. The use of these funding enhance the diversification and secures Madrid ability to tap the markets.

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 credit ratings, as the social factors affecting the Kingdom of Spain’s credit 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 (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 (low) – A range.

The main points discussed during the Rating Committee include the financial impacts for Madrid of the potential debt relief for Spanish autonomous communities, Madrid’s fiscal performance in 2023, financial forecasts and the situation of the regional 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 Autonomous Community 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 the Autonomous Community of Madrid for financial and budgetary position and debt structure from 2016 to 2022 and budget execution up to October 2023, 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 October 2023 Budget fundamental lines report, for its April 2023 Individual Report on the Initial Budget of Autonomous Community of Madrid, and for its economic and financial information observatory of Autonomous Communities, 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 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/425386.

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: February 01, 2019
Last Rating Date: June 16, 2023

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