Morningstar DBRS Upgrades the Autonomous Region of Madeira to BBB, Changes Trend to Stable

DBRS Ratings GmbH (Morningstar DBRS) upgraded the Autonomous Region of Madeira's (Madeira or the Region) Long-Term Issuer Rating to "BBB" from BBB (low) and upgraded the Short-Term Issuer Rating to R-2 (middle) from R-2 (low). The trends on all ratings changed to Stable from Positive.

KEY CREDIT RATING CONSIDERATIONS
The upgrade of Madeira's credit ratings reflects the upgrade of the Republic of Portugal's Long-Term Foreign Currency and Long-Term Local Currency Issuer Rating to A (high) from "A" on 17 January 2025, in addition to Madeira's continued fiscal improvement, supported by the growth in tax revenues stemming from the strong economic momentum. This fiscal improvement should allow the Region to continue making progress with the declining trajectory of its debt. Moreover, the Portuguese central government strongly supports the Region, especially through guarantees on its long-term funding as granted again in Portugal's 2025 state budget.

Madeira's credit ratings are underpinned by (1) its strong willingness to continue to improve its fiscal performance and to maintain its deleveraging path, (2) the financial oversight and support to the Region from Portugal, and (3) the implementation of public finance reforms including the development of budgetary forecasting models.

CREDIT RATING DRIVERS
The credit ratings could be upgraded if (1) Madeira were able to maintain its deleveraging path; or (2) the Portuguese sovereign credit ratings were upgraded; or (3) there were indications of a further strengthening of the relationship between the region and the central government.

The credit ratings could be downgraded if one or a combination of the following occurred: (1) there is a structural reversal in Madeira's fiscal consolidation leading to substantially higher debt; (2) there are indications that the financial support and oversight currently provided by the central government weaken; or (3) the Portuguese sovereign credit ratings were downgraded.

CREDIT RATING RATIONALE

Madeira's Economic Performance to Remain Stronger than the National One; Growth Driven by Tourism and EU Funds

Madeira's economy continues to outperform the national average, boosted by very positive momentum in the hospitality sector in the last three years. After a strong performance in 2023, overnight stays grew by 6% and tourist accommodation revenues by 15% between January to October 2024, compared to the same period in 2023. The robust results of the tourism sector underpin Madeira's strong economic performance. Madeira's real GDP growth reached a very high 16.5% in 2022 versus the national average of 7.0%. The National Statistical Institute estimates Madeira's GDP growth at 4.5% in 2023, above 2.5% for Portugal.

Madeira's employment rate improved to 57.1% in Q3 2024, from 56.5% in Q3 2023, which is above the pre-pandemic level of 54.6% registered in Q3 2019. Similarly, the unemployment rate remained relatively low at 5.7% in Q3 2024, after recording its lowest value in the last 20 years of 4.9% at Q3 2023 and is expected to remain stable whilst the population is expected to grow thanks to immigration. Additionally, the implementation of reforms and investments associated with EU funds are positively impacting Madeira's economy. The Region is expected to receive EUR 1.4 billion in subsidies from the EU, including EUR 760 million related to traditional regional operational programs (European Regional Development Fund and European Social Fund) but also EUR 706.7 million related to the RRF that was reviewed upwards from EUR 561 million, and EUR 86 million related to REACT-EU. These funds represent around one quarter of Madeira's estimated 2022 GDP. The regional government expects economic growth to continue outperforming the national average until 2027, when the economic growth is expected to decrease as a result of the winding down of these funds.

Political Turmoil to Continue in 2025 But Financial Performance Improvement Remains Unaltered Towards Surpluses

Madeira's government has recently been subject to some instability. This is reflected in the fact that the region of Madeira will hold elections for the third time during the last two years. Before that, the government was formed by the Social Democratic Party (PSD) and the Centro Democratico e Social- Partido Popular (CDS-PP) but there was a lack of support to pass the 2025 budget, and the government collapsed due to a motion of censure posed by Chega and supported unanimously by all the opposition.

The Region has so far been complying with the budgetary targets set by the national and regional governments, which underpinned the improvement in its fiscal performance. Morningstar DBRS is of the opinion that central government will continue to foster the Region's fiscal rebalancing within the new economic governance framework approved at the European level that should now be translated to the national and subnational Portuguese public sectors. Despite the lack of budget and the political turmoil, Morningstar DBRS believes that the risk of fiscal slippage is limited since the 2024 budget, which has resulted in positive fiscal results, is being rolled over under a duodecimal system. This duodecimal system allows the region to operate normally and to implement investments cofinanced through EU funds and to update public salaries but restricts new expenditure and revenue policies to be implemented.

Madeira's financial performance improved significantly in 2023. The Region achieved a financing surplus accounting of 3.4% of operating revenues following a deficit of 9.7% in 2022. This better fiscal outcome stemmed from the improvement in operating performance and decrease in capex. The financial performance continued to improve for the period from January to November 2024. The operating surplus increased to 7.5% of operating revenues from 6.8% in 2023 and the financing surplus improved further to 7.6% of operating revenues from 3.4% in 2023 as a result of lower capital expenditure due to the late approval of the regional 2024 budget. The Region's satisfactory operating performance is driven by the high level of fiscal revenues that the region is collecting, mainly from the value added tax and the corporate tax receipts. These elevated fiscal revenues have benefitted from the strong economic performance. However, part of these revenues might not be the result of a structural change as they have benefitted from still elevated inflation and extraordinarily high corporate tax collection that is not expected to be repeated. During 2023 and 2024, many corporates established in the CINM regularised their tax situation with the administration, resulting in the region collecting some fiscal revenues that corresponded to previous fiscal exercises. The total amount of revenue that is still pending to be settled amount up to EUR 754 million, depending on court decisions.

Debt Ratio Is Declining at a Fast Pace But Remains Still Very High and State Support Remains Key

Madeira's direct debt remain stable at EUR 4.7 billion in 2024, being the first year that the debt has not increased in the last decade. The debt stock variation is conditioned by the reduction or absorption of the Region's indirect debt onto its own balance sheet¿for those public entities reclassified in ESA terms¿, which has decreased to EUR 0.1 billion in 2024 from EUR 0.4 billion in 2022, and the decline in the public and private partnerships related liabilities. During the last decade, Madeira had already consolidated most of the public sector debt (which accounted for EUR 1.8 billion in 2013) into its administration's debt. Morningstar DBRS expects the Region will now be able to stabilise direct debt or even achieve a declining trend, as long as its fiscal performance remains strong. The Region has for the last four years used their excess of cash to fund its deficits and decrease its Morningstar DBRS-adjusted debt stock. With the strong and continued rise in operating revenues, the Region was able to strongly reduce its debt-to-operating revenues ratio to 366% at the end of 2023, and Morningstar DBRS expects this ratio to further decline to around 340% of operating revenues in 2024. Nevertheless, Madeira remains one of the most indebted regions in Europe, a factor that continues to weigh on its overall credit profile, but Morningstar DBRS expects a continuation of the Region's declining debt ratio trajectory, supported by its strong fiscal performance and economic growth.

For its 2025 funding needs Madeira will benefit again from the explicit guarantee from the central government, the limit of which was increased in the 2025 Portuguese national budget. The region has already contracted a EUR 72 million loan and expects to contract another loan for EUR 50 million, and to issue EUR 310 million bonds in the first half of 2025. Also, the region plans to fund EUR 44 million with operating regional revenues. Debt capital repayments for this year are comparatively high at EUR 476 million compared with EUR 279 million in 2024. The region has secured similar funding levels in recent years and debt covenants granted by the support of the central government partly mitigates the refinancing risk. The Region's liquidity is currently satisfactory with an average cash balance of EUR 146 million in 2024, supported by a EUR 30 million facility available with the Portuguese Treasury as well as EUR 50 million bank credit facility. Moreover, the Region benefits from a EUR 158.7 million non-disbursed loan with the Council of Europe Development Bank, guaranteed by Portugal and available until 2028 to fund the construction work related to Madeira's new university hospital.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG Considerations had a relevant effect on the credit analysis.

Social (S) Factors

The following Social factors had a relevant effect on the credit analysis: The Passed-through Social credit considerations have a relevant effect on the credit ratings, as the social factors affecting Portugal's credit ratings are partially passed through to Madeira. Portugal's relatively low level of human capital, as measured by GDP per capita, is factored into the sovereign credit rating, which has been used as an important input for Madeira's credit ratings. Madeira's GDP per capita represented 101% of the national average in 2022 but during the last several years, it was usually below the national average, for instance, prior to the coronavirus pandemic, it was at approximately 97% of the national average in 2019.

Governance (G) Factors

Since the last rating action the relevance or significance of the following Governance Factor changed: Institutional Strength, Governance, and Transparency. While Morningstar DBRS considered this factor to affect positively the credit ratings assigned before, currently the institutional arrangements provide a comparable degree of accountability, transparency and effectiveness with peers on the same rating category (rated "BBB", Stable).

Credit rating actions on Republic of Portugal are likely to have an impact on this credit rating. ESG factors that have a significant or relevant effect on the credit analysis of Autonomous Region of Madeira are discussed separately at https://dbrs.morningstar.com/issuers/17486.

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 Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

RATING COMMITTEE SUMMARY
Morningstar DBRS' European Sub-Sovereign Scorecard generates a result in the BBB (low) - BBB (high) range. The main points discussed during the Rating Committee included the fiscal and financial impacts of the upgrade of Republic of Portugal's rating, the fiscal and debt evolution in 2024, the economic situation in the region and its outlook, and its financial forecasts.

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/445934.

The national scorecard indicators were used for the sovereign rating. The Republic of Portugal 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 the Rating European Sub-Sovereign Governments (09 August 2024) https://dbrs.morningstar.com/research/437618. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 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 Autonomous Region of Madeira for the 2017-2023 financial statements, 2024 monthly budgetary execution, debt and liquidity situation, 2025 National budget, 2024 Programa do Governo, Instituto Nacional de Estatística (INE) and Direcao Regional de Estatística da Madeira (DREM) national statistical agency, central bank, Ministry of Finance, IMF, World Bank. 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/446376.

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: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: 15 June 2018
Last Rating Date: 26 July 2024

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