DBRS Assigns First-Time BBB (low) / R-2 (low) Issuer Ratings to the Autonomous Region of the Azores

DBRS Ratings GmbH (DBRS) assigned a Long-Term Issuer Rating of BBB (low) to the Autonomous Region of the Azores (Azores) and a Short-Term Issuer Rating of R-2 (low). The trend on the ratings is stable.

KEY RATING CONSIDERATIONS

The Azores’ ratings are underpinned by (1) the region’s sound operating results and its overall stable financial performance over the last five years, supported by favourable economic conditions in the region and in Portugal as a whole; (2) the region’s high but only marginally increasing debt ratio and; (3) the recentralisation over the last 24 months of several public services (healthcare, urban and housing rehabilitation) previously carried out by regional companies, onto the regional administration’s own budget, and the related efficiency gains expected from these operations. DBRS also views the relationship between the region and the Republic of Portugal as key for its assessment of the Azores’ credit profile.

The region also faces structural challenges. DBRS considers that regional companies in the Azores, most of which continue to post weak financial results, still weigh on the region’s creditworthiness. In particular, the Azores’ 100% ownership of the loss-making regional airline group, SATA, remains a concern for DBRS. In line with the Autonomous Region of Madeira (BB, Positive), the Azores’ geographical location, as an archipelago in the Atlantic Ocean, also remains a challenge to its overall credit profile.

The Stable trend on the ratings reflects DBRS’s view that the risks to the region’s ratings are balanced. While DBRS points out that any rating upgrade of the Republic of Portugal’s rating (BBB, Positive), would affect positively its assessment of the region’s credit profile, it would likely be insufficient to prompt a rating upgrade of the Azores’ ratings. DBRS considers that most economic and fiscal improvements expected at the national level and positively affecting the Portuguese public sector are in large part already factored in the BBB (low) rating of the region.

RATING DRIVERS

Upward rating pressure on the Azores’ ratings could materialise if any or a combination of the following factors occur: (1) the Azores materially reduces its indebtedness and risk exposure to its regional companies; (2) the region’s economic indicators continue to improve and the Azores manages to diversify its economy further; or (3) there are indications of a further strengthening of the relationship between the region and the central government.

Downward rating pressure could materialise if any or a combination of the following factors occur: (1) the Azores’ operating performance deteriorates and the region incurs large deficits that prompt a substantial rise in its debt ratio; (2) a significant deterioration in the regional companies’ financial performance occurs, potentially prompting guarantee calls or a marked weakening of the region’s debt metrics; or (3) indications that the relationship between the region and the central government would be weaker than currently considered.

RATING RATIONALE

Solid Economic Growth Boosted by Tourism Supports a Sound And Steady Financial Performance

The region has delivered solid real gross domestic product (GDP) growth since 2015, at an average annual rate of 2.5%, marginally outperforming the 2.2% Portuguese average over the same period. The economic growth was supported by steady expansion of the tourism sector within the region’s territory. For example, air passenger arrivals to the region almost doubled from 465,000 in 2014, to 935,000 in 2018. This substantial growth reflected the liberalisation of several airline routes between the region and the Portuguese mainland in 2015. Going forward, tourist arrivals should stabilise as the market matures, but DBRS will monitor their evolution to assess for any indication of a reversal in the positive trend recorded since 2015.

The Azores’ financial performance has been relatively stable in the last five years, with the region recording solid operating results and small, albeit recurring, financing deficits. Taking into account capital revenues and expenditure, deficits have averaged around 6% of the region’s operating revenues. This stable performance reflected a slow but steady growth in operating revenues, largely driven by higher tax collection (particularly value added tax) following solid economic growth. Good control over regional operating expenditure despite relatively flat transfers from the central government also supported stable fiscal outcomes. Sound operating performance allowed the region to allocate more than a quarter of its budget to capital expenditure programmes, a positive feature in DBRS’s view. Continued economic growth in Portugal and in the region should support a further strengthening of the region’s performance, with the expectation of near-balanced budget positions.

Recentralisation of Debt is Expected to Enhance Cost Control But Regional Companies Remain a Credit Challenge

The Azores’ adjusted debt stock as calculated by DBRS, which includes direct debt and also indirect and guaranteed debt of several regional companies, represented 227% of the region’s operating revenues at the end of 2018. While this ratio has only marginally increased since 2014 when it was close to 200%, it is high by international comparisons and upward trending, a negative credit feature for DBRS. Nevertheless, the fact that part of the recent debt increase was driven by the implementation of capital expenditure programmes rather than operating deficits somewhat mitigates that risk. The region’s debt ratio also compares very favourably on a national basis, as its debt-to-operating revenue ratio remains substantially lower than that of Madeira (498% in 2018).

DBRS also views positively the changes implemented in the last 24-months to recentralise part of the regional companies’ debt onto the region’s own balance sheet. These operations were concomitant with the dissolution of two regional companies managing urban and housing rehabilitation and healthcare, respectively. This recentralisation of public services should enhance the region’s control over service provision and rationalise some of the related costs, particularly with regard to debt service.

Some challenges regarding the overall regional public sector remain. DBRS views in particular the 100% regional ownership in the loss-making SATA Group as a key challenge. The group includes two airlines, two tour operators, and an airfield management division. While the region is currently considering reducing its stake to 51% in one of the companies of the group (SATA Internacional), DBRS considers that concluding any operation would take time and might include a recapitalisation, which could add to the region’s indebtedness. DBRS would see the involvement of a credible private investor that strengthens SATA’s financial performance, as positive.

Sovereign Support Remains Key To the Azores’ Ratings

While the Azores does not benefit from any explicit guarantee from the central government, DBRS does consider that any assistance provided to Madeira by the Portuguese government would be available to the Azores if ever necessary. This assessment is supported by the fact that the region benefited from the central government’s debt financing in 2012, at the peak of the European sovereign debt crisis.

RATING COMMITTEE SUMMARY

The DBRS European Sub-Sovereign Governments Scorecard generates a result in the BBB – BB (high) range. The main points discussed during the Rating Committee include the Azores’ financial performance, its debt levels and the debt related to public companies, and the region’s relationship with the Portuguese government.

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 the Azores.

Fiscal Balance (% GDP): -0.5 (2018); -0.4 (2019F); -0.1 (2020F)
Gross Debt (% GDP): 121.5 (2018); 119.2 (2019F); 116.6 (2020F)
Nominal GDP (EUR billions): 201.6 (2018); 207.8 (2019F); 214.8 (2020F)
GDP per Capita (EUR): 19,615 (2018); 20,227 (2019F); 20,919 (2020F)
Real GDP growth (%): 2.1 (2018); 1.7 (2019F); 1.7 (2020F)
Consumer Price Inflation (%): 2.1 (2018); 1.7 (2019F); 1.8 (2020F)
Domestic Credit (% GDP): 257.2 (2017); 246.5% (2018)
Current Account (% GDP): -0.6 (2018); -1.0 (2019F); -1.1 (2020F)
International Investment Position (% GDP): -100.8% (2018); -100.9% (March-2019)
Gross External Debt (% GDP): 204.7 (2018); 203.6% (March-2019)
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 the Azores, 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: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions and Sovereign Ratings Group
Initial Rating Date: 12 July 2019
Last Rating Date: Not applicable

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