DBRS Confirms the Autonomous Region of Madeira at BB, Trend Changed to Positive

DBRS Ratings GmbH (DBRS) confirmed the Long-Term Issuer Rating of the Autonomous Region of Madeira (Madeira) at BB and Short-Term Issuer Rating at R-4. At the same time, DBRS changed the trend on the Long-Term Issuer Rating to Positive from Stable; the trend on the Short-Term Issuer Rating remains stable.

KEY RATING CONSIDERATIONS

The trend change follows the trend change to Positive from Stable of the Republic of Portugal’s Long-Term Foreign and Local Currency – Issuer Rating of BBB on 5 April 2019. The trend change at the sovereign level reflected DBRS’s view that risks to the ratings are tilted to the upside. In particular, Portugal’s fiscal deficit is slowly approaching balance and the government debt-to-GDP ratio as well as Portuguese banks’ non-performing loans are declining at a healthy pace. In addition, economic growth in the country is expected to remain above euro area average in the foreseeable future. Given the economic and financial linkages between both government tiers, Portugal’s trend change affects positively DBRS’s analysis of Madeira’s creditworthiness and supports the region’s trend change to Positive.

Madeira’s ratings remain underpinned by (1) the region’s stabilising financial performance over the last few years and improving debt metrics supported by more favourable economic indicators; (2) the financial oversight and support to the regional government from the Republic of Portugal; and (3) Madeira’s enhanced control over its indirect debt as well as commercial liabilities in the last few years through a gradual recentralisation of these liabilities onto its own balance sheet.

RATING DRIVERS

Madeira’s rating could be upgraded if any or a combination of the following occur: (1) the Portuguese sovereign rating is upgraded; (2) Madeira substantially reduces its indebtedness; (3) Madeira’s economic indicators continue to improve and the region manages to further diversify its economy; or (4) there are indications of a further strengthening of the relationship between the region and the central government.

Although less likely given the Positive trend on the rating, negative downward pressure could materialise if any or a combination of the following occur: (1) there is a negative rating action on the Portuguese sovereign; (2) Madeira fails to stabilise its financial performance and debt metrics over the medium-term; (3) indications emerge that the financial support and oversight currently provided by the central government weaken; or (4) there is a reversal in the reduction of the region’s indirect and guaranteed debt.

RATING RATIONALE

Strengthening Fiscal Performance since 2013 and Steadily Declining But Still Very High Debt Metrics

Madeira’s overall fiscal performance has substantially improved in the last five years. In particular, expenditure control and some growth in tax revenues, reflecting tax hikes and economic growth, have allowed the region to deliver a stronger financial performance. The region’s deficit represented 3% of operating revenues at the end of 2018 (provisional figures), down from a very large 74% at the end of 2013. While the 2013 financial performance largely reflected one-off measures with sizeable capital injections into public companies, DBRS notes that reduction in the region’s financing deficit has been steady although it has required continuous efforts from the regional government.

After a modest deterioration in 2017, the region’s financial performance improved again in 2018. This positive credit development primarily reflected the pick-up in corporate income tax and value added tax compared to the previous year. While DBRS highlights that Madeira remains subject to volatility in its tax revenues, its overall fiscal performance should remain sound going forward, at a near balanced budget position.

Solid gross domestic product (GDP) growth, supported by a steady rise of the tourism sector in the region and stronger fiscal performance have allowed Madeira to decrease its extremely high debt ratios since 2012. While in an international comparison, the region’s debt-to-operating revenues at 498% at the end of 2018 (provisional figures) remains very high, DBRS views positively the downward trend it has recorded in the last few years. However, Madeira’s debt ratios continue to represent, in DBRS’s view, the main drag on the region’s ratings.

Enhanced Oversight and Sovereign Guarantees Support the Rating

DBRS acknowledges that the region has taken substantial steps to increase transparency and monitoring around its indirect and guaranteed debt, but also to reduce its DBRS-adjusted debt stock (which includes direct, indirect and guaranteed debt, commercial obligations and Public Private Partnerships related obligations). In addition, the national government’s support via the Portuguese Treasury and Debt Management Agency (IGCP) is a positive credit feature for the region as it strengthens its overall debt management. Nevertheless, the sustained growth in Madeira’s direct debt obligations and the very high debt stock it has accumulated over time continue to weigh considerably on the region’s ratings.

The explicit guarantees provided by the central government for the refinancing of the regional debt and DBRS’s expectation that this support will continue going forward are positive credit features supporting Madeira’s ratings. The region’s refinancing needs have therefore fully benefited from the national government’s explicit guarantee in 2018 and will continue to do so in 2019. Going forward, while the region’s financial performance is expected to slowly improve, additional debt reductions of a significant scale will be critical for the region to strengthen its credit profile further.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the BB (high) – BB (low) range. The main points discussed during the Rating Committee include the relationship between the central government and the Autonomous Region of Madeira, the debt metrics and financial performance of the region in the last two years, the region’s governance.

KEY INDICATORS FOR THE REPUBLIC OF PORTUGAL

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

Fiscal Balance (% GDP): -0.5 (2018); -0.6 (2019F); -0.2 (2020F)
Gross Debt (% GDP): 121.5 (2018); 119.2 (2019F); 116.8 (2020F)
Nominal GDP (EUR billions): 201.6 (2018); 208.4 (2019F); 215.3 (2020F)
GDP per Capita (EUR): 19,589 (2018); 20,260 (2019F); 20,939 (2020F)
Real GDP growth (%): 2.1 (2018); 1.8 (2019F); 1.7 (2020F)
Consumer Price Inflation (%): 1.7 (2018); 1.6 (2019F); 1.8 (2020F)
Domestic Credit (% GDP): 256.1 (2017); 247.9% (Sep-2018)
Current Account (% GDP): -0.6 (2018); 0.1 (2019F); 0.0 (2020F)
International Investment Position (% GDP): -104.9% (2017); -100.8% (2018)
Gross External Debt (% GDP): 209.4 (2017); 204.7% (2018)
Governance Indicator (percentile rank): 87.5 (2017)
Human Development Index: 0.85 (2017)

Notes:

All figures are in euros (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. The 2018 fiscal balance and gross debt figures from latest Agência de Gestão da Tesouraria e da Dívida Pública. Forecasts from European Commission. Fiscal balances include one-offs related to capital injections to Novo Banco (0.4% in 2018). GDP and inflation figures and forecasts from Instituto Nacional de Estatistica Portugal and the European Commission. Domestic credit and external debt from Bank of Portugal and Instituto Nacional de Estatistica Portugal. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating European Sub-Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include the Autonomous Region of Madeira, Bank of Portugal, Instituto Nacional de Estatística (INE). DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Nicolas Fintzel, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Co-Head of Sovereign Ratings - Global Sovereign Ratings
Initial Rating Date: 15 June 2018
Last Rating Date: 19 October 2018

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