Morningstar DBRS Confirms the Autonomous Region of Madeira at BBB (low), Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Long-Term Issuer Rating of the Autonomous Region of Madeira (Madeira) at BBB (low) and Madeira's Short-Term Issuer Rating at R-2 (low). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
Madeira’s credit 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", Stable); and (3) Madeira’s implementation of public finance reforms including the development of budgetary forecasting models.

The Stable trend reflects Morningstar DBRS' assessment that the risks to Madeira's credit ratings are balanced. The 2023 budgetary execution confirms the ongoing rebalancing of Madeira's fiscal performance. The strong improvement of the fiscal performance is supported by growing revenues, thanks notably to very positive momentum of the regional tourism sector since 2022. However, the region's debt burden remains very high. Additionally, the higher-for-longer interest rate environment and remaining inflationary pressures could weigh on its economy and fiscal performance. Nevertheless, the strengthening of the region’s debt management in recent years should mitigate interest rate risk in the near term. Moreover, the Portuguese central government strongly supports the region, especially through guarantees on its long-term funding, as granted again in the 2024 State budget.

CREDIT RATING DRIVERS
Madeira's credit ratings could be upgraded if any or a combination of the following occur: (1) Madeira is able to maintain its deleveraging path; (2) there are indications of a further strengthening of the relationship between the region and the central government; or (3) the Portuguese sovereign credit rating is upgraded.

Madeira's 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 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 credit rating is downgraded.

CREDIT RATING RATIONALE
Continuation of Strong Tourism Momentum Drives Regional Economic Performance and Allows Madeira to Boost Fiscal Consolidation

The very positive momentum in the hospitality sector continued at a fast pace during 2023. As of November 2023, overnight stays and revenues from tourism accommodation were respectively 14% and 27% above their level for the same period in 2022, supporting overall economic performance. Madeira's real GDP growth reached a very high 14.2% in 2022 versus a national average of 6.8%. Since the COVID-19 pandemic, the economic recovery has been stronger than nationally and Madeira had been able to close the gap with the national GDP growth in the last ten years. For the first time since 2005, GDP per capita is slightly higher than the national average accounting for 101% of the latter. The regional labor market has also benefitted from economic growth with an unemployment rate of 4.8% in Q3 2023, which is now below the national unemployment rate of 6.1% and which has considerably improved from 11.4% on average during 2015-2019.

This very favorable economic context allowed Madeira to continue its fiscal consolidation path thanks to the increase of revenues and stronger cost control. The region was able to post last year an operating surplus accounting for around 7% of its operating revenues, an improvement compared with a surplus of 0.8% in 2022, and operating deficits amounting to 17.3% of its revenues in 2021 and 8.5% in 2020. The region is expected to have posted a financing surplus in 2023 compared with financing deficits of 9.7% of operating revenues in 2022 and of 24.9% in 2021. In 2023, operating revenues grew by an estimated 17% mainly supported by the growth of direct taxes. At the same time, the wind-down of COVID-19-related spending contributed to the budgetary performance improvement. Morningstar DBRS will pay particular attention to the region’s medium-term budgetary plan and its capacity to continue to execute on its deleveraging goal.

Madeira Has Brought Back its Debt-to-Operating Revenues Ratio Below 380% 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 to decrease its Morningstar DBRS adjusted debt stock in the last three years. With the continued rise in operating revenues, Morningstar DBRS estimates that the region was able to strongly reduce its debt-to-operating revenues ratio to less than 380% in 2023 which is now below the pre-COVID-19 debt level. Nevertheless, Madeira remains one of the most indebted regions in Europe, a factor that continues to weigh on its overall credit profile.

Thanks to its active debt management strategy, the region has been able to reduce its exposure to interest risk, which is positive in the current higher-for-longer interest rate environment, with direct debt exposure to variable rates currently at 40% from 75% at year-end 2019. 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 and reduces refinancing risk.

Sovereign Guarantees Will Continue to Support the Rating Regardless of Snap National Elections And New Government Likely to Continue Fiscal Consolidation

The explicit guarantees provided by the central government for the refinancing of the region’s debt and Morningstar DBRS’ expectation that this support will continue are positive credit features, critical for Madeira's credit rating. In 2023, 81% of Madeira’s direct debt was either lent or guaranteed by the Republic of Portugal. The region’s refinancing needs have fully benefited from the national government’s explicit guarantee in recent years, and Morningstar DBRS expects this again to be the case in 2024. Any indication that the central government's support to the region is weaker than currently foreseen, would be credit negative for Madeira.

Following the September 2023 regional elections, the coalition formed by the Social Democratic Party (PSD) and the Centro Democratico e Social- Partido Popular (CDS-PP) remains in power. We continue to expect that fiscal consolidation and debt control will remain a priority for the government. Additionally, snap elections for the Republic of Portugal will take place in March 2024. Morningstar DBRS does not expect those national elections to negatively impact the institutional arrangements between the central government and the region.

ENVIRONMENTAL, SOCIAL, AND 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 Republic of Portugal’s credit ratings are passed-through to Madeira.

Governance (G) Factors

The Institutional Strength, Governance and Transparency factor affects the credit 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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 main developments in political landscape, the central government support, Madeira’s fiscal performance in 2023, financial forecasts and the situation of the regional economy.

For more information on the Key Indicators used for the Republic of Portugal, please see the Sovereign Scorecard Indicators and Building Block Assessments: https://dbrs.morningstar.com/research/426949/portugal-republic-of-scorecard-indicators-and-building-block-assessments.

The national scorecard indicators were used for the sovereign credit rating. The Republic of Portugal’s credit rating was an input to the credit analysis of the Autonomous Region of Madeira.

Notes:
All figures are in Euros unless otherwise noted.

The principal methodology is Rating European Sub-Sovereign Governments (August 11, 2023) https://dbrs.morningstar.com/research/419048/rating-european-sub-sovereign-governments. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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 credit rating include Autonomous Region of Madeira for the 2017-2022 financial statements, 2023 monthly budgetary execution, debt and liquidity situation, 2024 National budget, 2024 Draft regional budget, Instituto Nacional de Estatística (INE) and Direcao Regional de Estatística da Madeira (DREM). Morningstar DBRS considers the information available to it for the purposes of providing this credit rating to be of satisfactory quality.

Morningstar DBRS 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. Morningstar DBRS’s outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS 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 Morningstar DBRS 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://dbrs.morningstar.com/research/427203.

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: Nichola James, Managing Director, Credit Ratings, Global Sovereign Ratings
Initial Rating Date: June 15, 2018
Last Rating Date: July 28, 2023

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