Morningstar DBRS Changes Trend on the Autonomous Community of Madrid to Positive, Confirms Ratings at "A"

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Autonomous Community of Madrid's (Madrid) Long-Term Issuer Rating at "A" and Short-Term Issuer Rating at R-1 (low). At the same time, Morningstar DBRS changed the trend on Madrid's Long-Term Issuer Rating to Positive from Stable. The trend on Madrid's Short-Term Issuer Rating is Stable.

KEY CREDIT RATING CONSIDERATIONS
The Positive trend is underpinned by Morningstar DBRS' trend change on the Kingdom of Spain's Long-Term Foreign and Local Currency - Issuer Rating (rated "A" by Morningstar DBRS) to Positive from Stable on 31 May 2024, and also reflects Morningstar DBRS' view of Madrid's favorable fiscal outlook and expected improvement in debt affordability. Madrid's strong financial management combined with the return of fiscal rules should allow the region to continue making progress with its declining debt trajectory.

Madrid's credit ratings are underpinned by (1) the region's large and diversified economy; (2) its strong fiscal results since 2018, which Morningstar DBRS expects to continue; (3) its sound debt structure and consistent access to financial markets; and (4) its strengthened liquidity profile. Despite the pressures related to high interest rates, Morningstar DBRS anticipates that the region's strong management will be able to control the growth in expenditures and limit debt accumulation.

CREDIT RATING DRIVERS
The credit ratings could be upgraded if 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 trend on Madrid's long-term issuer rating could return to Stable if the positive trend on the Kingdom of Spain reverts to Stable. 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 larger and costlier annual maturities and higher leverage; or (3) the Kingdom of Spain's credit ratings are downgraded.

CREDIT RATING RATIONALE
Revenue Growth and Return of Fiscal Rules Supports a Strong Fiscal Outlook

Madrid's operating performance improved in 2023. Nevertheless, higher investment level translated into a stabilization of the financing deficit at 0.7% of GDP under national accounting standards. The operating surplus reached EUR 236 million or 1.0% of operating revenues from an operating deficit of EUR 303 million or 1.4% of operating revenues in 2022 thanks to higher tax revenues and the positive settlement from the regional financing system. However, capital expenditure net of capital revenue increased to EUR 1.5 billion from EUR 0.4 billion in 2022, weighing on the financing result and leading to a deficit of EUR 1.2 billion or 5.3% of operating revenues at the end of 2023 versus EUR 0.7 billion or 3.4% of operating revenues in 2022.

Despite a stable financing deficit in 2023, Morningstar DBRS views positively the improvement in operating performance and the recovery in revenues and expects the region to improve its financing result in 2024. This would be driven by the continuation of tax revenue growth, boosted by the sound labour market, and higher capital revenues in combination with the return of the budget stability law, which would likely increase the grip on expenditures. Moreover, Morningstar DBRS considers that Madrid has some budgetary flexibility that could be used against potential fiscal headwinds, since the region has created some fiscal headroom after a long period of taxes cutting. The Independent Authority for Fiscal Responsibility (AIREF) expects Madrid's financing result to improve to a deficit of 0.1% of GDP in 2024, which is less favourable than previously expected due to the weaker financing result in 2023 but a substantial improvement in comparison with the last two years. Moreover, AIREF, in their medium-term projections foresees the region reaching a balanced budget and even a financing surplus from 2026 onward.

Madrid's Debt Profile Remains Strong And Potential Debt Relief May Further Increase Sustainability

Madrid increased its debt stock in 2023, mainly due to its own deficit but also due to the increase of the debt of its government-related entities, mainly Metro de Madrid which financed rolling stock. At the end of 2023, Morningstar DBRS' adjusted debt stock increased to EUR 39.7 billion from EUR 37.0 billion at the end of 2022. However, Madrid's debt sustainability position improved, with adjusted debt-to-operating revenues decreasing to 169% at the end of 2023, down from 176% in 2022. With a debt ratio of 14.0% of regional GDP at the end of 2023, the region's debt remains substantially below the average for Spanish regions of 22.9%. AIREF expects the debt ratio to decrease to 12.3% in 2024 in its report on the initial budget for 2024 (April 2024), and it also expects this ratio to keep declining over the medium term.

Moreover, Madrid's debt could potentially decrease further in the medium term due expected debt relief following the political agreement between the Partido Socialista Obrero Español and the Catalan party Esquerra Republicana de Catalunya that should be extended to all the autonomous communities (except for the Basque Country and Navarre). At this stage, few details on the form, date, and magnitude of this debt relief are available.

Madrid's debt is very diversified and the region benefits from consistent access to financial markets. The regional debt structure is very prudent with a large share of debt stock at long-term fixed rates that enhance the average life of debt and smooth the debt repayment calendar, reducing refinancing risk. For 2024, almost all of Madrid's funding needs were financed in the first half of the year through a mix of bond issuances, private placements, and bank loans.

Regarding liquidity, Madrid has historically recorded a relatively low cash position at the end of the year as well as during the year, as its liquidity needs are predictable and mainly depend on the calendar of settlements from the regional financing system. Nevertheless, Morningstar DBRS takes the view that Madrid's setup and successful launch of a pagarés (commercial paper) programme in 2020 and the extension of the credit lines available to the region to EUR 1.8 billion, bringing the region's liquidity toolkit to EUR 2.8 billion, have overall strengthened its liquidity profile. Going forward, Morningstar DBRS will continue to monitor the use of those liquidity instruments to assess their impact, if any, on the region's liquidity profile.

Despite External Headwinds, Madrid's Growth Is Diversified and Expected To Continue

Madrid's real GDP grew by 7.2% in 2022, better than Spain's growth rate of 5.8%, and AIREF expects Madrid's real GDP to have grown by 3.0% in 2023 and to grow by 2.1% in 2024. At the end of 2023, the services sector was driving growth with contributions from hospitality, transportation, and tourism. Meanwhile, industrial-related turnover grew by 3.5%, but the industrial production index had its first negative result after 27 months of positive values with a strong influence from the energy sector. Morningstar DBRS expects the regional economy growth to be supported by the region's high employment level and strong tourism performance. The financial resources expected from NextGenerationEU (NGEU), including the Recovery and Resilience Facility (RRF) and REACT-EU funds, should continue to support reforms and investments.

In April 2024, Madrid recorded an all-time employment level record with around 3.7 million workers, with 87% working in the services sector, after strong annual employment growth of 3.6%. The level of employment has remained elevated during the last two years and could partially explain why the region benefits from the highest GDP per capita in the country, estimated at EUR 38,435 in 2022, or 36% above the national average.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
General Considerations

ESG Considerations had a relevant effect on the credit analysis.

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 Madrid.

There were no Environmental or Governance 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 (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings

RATING COMMITTEE SUMMARY
Morningstar DBRS' European Sub-Sovereign Scorecard generates a result in the A (high) - A (low) range. The main points discussed during the Rating Committee included the fiscal and financial impacts of the potential upgrade of Kingdom of Spain's rating, the debt evolution in 2023, the economic situation in the region and its outlook, financial and fiscal forecasts, and also the financial impact for Madrid of the potential debt relief for Spanish autonomous communities.

For more information on the Key Indicators used for the Kingdom of Spain, please see the Sovereign Scorecard Indicators and Building Block Assessments: https://dbrs.morningstar.com/research/433832.

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 (15 April 2024) https://dbrs.morningstar.com/research/431201/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 (23 January 2024) 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://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Morningstar, Inc. and company documents. Other sources include the Autonomous Community of Madrid for financial and budgetary position and debt structure from 2016 to 2023, Madrid's Investor Presentation, Bank of Spain for the debt stock during the period between 2016 and 2023, Independent Authority for Fiscal Responsibility (AIREF) for its April 2024 Individual Report on the Initial Budget of Autonomous Community of Madrid, Instituto Nacional de Estadistica (INE), Ministry of Finance, General State Comptroller (IGAE), and the 2020 European Social Progress Index from the European Commission. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings 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' 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://www.dbrsmorningstar.com/research/434564.

These credit ratings are 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, Global Sovereign Ratings
Initial Rating Date: February 01, 2019
Last Rating Date: December 15, 2023

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