Morningstar DBRS Changes Trends on the Autonomous Region of Madeira to Positive, Confirms Ratings at BBB (low)

DBRS Ratings GmbH (Morningstar DBRS) changed the trend on the Autonomous Region of Madeira's (Madeira or the Region) Long-Term Issuer Rating to Positive from Stable and confirmed the ratings at BBB (low). At the same time, Morningstar DBRS changed the trend on Madeira's Short-Term Issuer Rating to Positive from Stable and confirmed the ratings at R-2 (low).

KEY CREDIT RATING CONSIDERATIONS
The Positive trends are underpinned by Morningstar DBRS' change of the trend on the Long-Term Foreign Currency and Long-Term Local Currency Issuer Ratings (both rated "A") of the Republic of Portugal (Portugal) to Positive from Stable on 19 July 2024. The Positive trends also reflect Morningstar DBRS' view of Madeira's continued fiscal improvement, supported by the growth in tax revenues stemming from 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 2024 state budget.

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

CREDIT RATING DRIVERS
The credit ratings could be upgraded if (1) the Portuguese sovereign credit ratings were upgraded; (2) Madeira were able to maintain its deleveraging path; or (3) there were indications of a further strengthening of the relationship between the region and the central government.
The trends on the credit ratings could return to Stable if the positive trends on Portugal's sovereign credit rating revert to Stable and the expected improvement of its intrinsic credit profile, especially deleveraging, does not materialize.
The credit ratings could be downgraded if one or a combination of the following occurred: (1) there were a structural reversal in Madeira's fiscal consolidation that led to new substantial debt accumulation; (2) indications emerged that the financial support and oversight currently provided by the central government had weakened; or (3) the Portuguese sovereign credit rating were downgraded.

CREDIT RATING RATIONALE

Stronger than National Economic Performance To Remain, Growth Driven By Tourism

Madeira's economy continues to outperform Portugal's national average, boosted by very positive momentum in the hospitality sector in the last three years. As of April 2024, overnight stays and revenues from tourism accommodation were respectively 5% and 10% above their levels for the same period in 2023. In 2023 Madeira already saw growth of 14% in overnight stays and 26% in revenues from accommodation compared with 2022. The robust results of the tourism sector underpin Madeira's strong economic performance. Madeira's real GDP growth reached a very high 14.2% in 2022 versus the national average of 6.8%. Moreover, in 2023 GDP growth is estimated at 2.7% for Madeira, above the 2.1% estimated for Portugal, according to the National Statistical Institute. EU funds are important in supporting the regional economy, employment growth and infrastructure development in Madeira. The amount of the RRF for Madeira has been revised upwards thanks to a reassessment of the GDP variation in 2020 and 2021 and the new REPowerEU initiative, for a combined amount close to EUR 145 million.

Madeira's employment rate improved to 60.2% at Q1 2024 from 57.6% at Q1 2023, which is far above the pre-pandemic level of 55.9% registered at Q1 2019. Similarly, the unemployment rate remained relatively low at 6.1% in Q1 2024, after recording its lowest value of the last 20 years at 4.8% in Q3 2023. Prior to the coronavirus pandemic, unemployment in both Portugal and Madeira had decreased rapidly since 2012 but until 2023, the Region structurally had slightly underperformed the national average. For the first time since 2005, GDP per capita is slightly higher than the national average, amounting to 101% of the latter, or EUR 23,675 in 2022.

Tax Revenue Growth Drives Fiscal Performance Improvement Above Expectations

Madeira's financial performance improved significantly in 2023 with a financing surplus accounting for 3.4% of operating revenues following a deficit of 9.7% in operating revenues in 2022. This fiscal improvement stemmed from an improvement in operating performance and a decrease in capital expenditures (capex). The operating surplus improvement was supported by higher tax revenues. In terms of capital investment, the Region increased the capital revenue it received from EU funds. However, capex slightly decreased because of difficulties implementing investments due to a shortage of labor or private sector capacity as well as the regional elections that took place in the last part of the year. Morningstar DBRS views Madeira's fiscal performance improvement as very positive for its credit standing and expects the Region to maintain favourable financing results, despite lower economic growth prospects from this year onward.

In 2023, operating revenue increased by 16.7% to EUR 1,444 million, boosted by an increase in direct taxes. Direct taxes benefitted from inflation, and corporate taxes experienced an extraordinary development that is not expected to be repeated. During 2023, many corporates established in the International Business Centre of Madeira (CINM) regularised their situation with the administration for around EUR 71 million. The EU reviewed which tax concepts could be deducted, which resulted in some tax reductions being deemed inappropriate and payable instead to the administration. At the same time, operating expenditures (opex) grew by 9.7% to EUR 1,345.9 million, mainly as a result of increases in health and education spending that totalled 55% of operating expenditure in 2023 from 52% in the previous year.

The Region has so far been complying with the budgetary targets set by the national and regional governments, which have served to improve its fiscal performance, and Morningstar DBRS is of the opinion that fiscal rebalancing will continue to be stimulated by the central government in light of the new economic governance framework approved at the European level that should now be translated to the national and subnational Portuguese public sectors.

Debt Ratio Benefited from Economic and Fiscal Performance But Debt Remains Stable and Recentralization of Public Sector Debt is Almost Finished

Madeira's direct debt increased to EUR 4.7 billion in 2023 from EUR 4.5 billion in 2022. The debt increase is offset by the reduction or absorption of the Region's public sector debt or indirect debt, which decreased to EUR 0.1 billion in 2023 from EUR 0.4 billion in 2022, and also by the absorption of commercial debt. However, during the last decade, Madeira already integrated most of the public sector debt (which accounted for EUR 1.8 billion in 2013) into its administration's debt and 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.

Morningstar DBRS focuses its debt analysis on the level and trend in Madeira's adjusted debt. This measure factors in the Region's direct, indirect, and guaranteed debt as well as its public-private partnerships and commercial obligations. The Region decreased its Morningstar DBRS-adjusted debt stock in the last three years. With the continued rise in operating revenues, the Region was able to strongly reduce its debt-to-operating revenues ratio to 370% at the end of 2023, which is the lowest value for a decade. 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 strong fiscal performance and economic growth.

For its 2024 funding needs, Madeira benefited again from the explicit guarantee of the central government on two loans for a total of EUR 225 million and the remainder, EUR 54 million, is expected to be covered with operating regional revenues. Debt capital repayments for this year are comparatively low at EUR 279 million compared with above EUR 500 million in 2022, or compared to an average of around EUR 370 million for the next five years.

The Region's liquidity is currently satisfactory with an average cash balance of EUR 132 million during 2023, supported by a EUR 30 million facility available with the Portuguese Treasury as well as EUR 100 million of credit facilities with various banks. 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.

Political Instability Not To Threaten Fiscal and Financial Outlook

Madeira's government has recently been subject to some volatility. A coalition government was formed by the Social Democratic Party (PSD) and the Centro Democratico e Social- Partido Popular (CDS-PP) after the September 2023 elections. However, the president of the Regional Government announced on 26 January 2024 that he would resign from his position, amid a corruption investigation that ultimately led to snap elections on 26 May 2024. The PSD won the elections, but lacking a full majority, it needs support from other parties. On 4 July 2024, the PSD managed to approve its government program with the support of the CDS-PP and PAN party, and the regional parliament passed the 2024 budget on the 19 of July 2024.

Despite the political instability in the last part of 2023 and beginning 2024, the fiscal data up to the first quarter of 2024 confirms a continuation of the fiscal consolidation, and the approval of the budget reduces the uncertainty. At this stage, Morningstar DBRS does not expect the government instability to impact Madeira's credit ratings.

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

Social (S) Factors

The following Social factor 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.

Governance (G) Factors

The following Governance factor had a significant effect on the credit analysis: The Institutional Strength, Governance and Transparency factor affects the credit ratings. 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 factor that had a relevant or significant 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

RATING COMMITTEE SUMMARY
Morningstar DBRS' European Sub-Sovereign Scorecard generates a result in the BBB (high) - BBB (low) 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/436410.

The national scorecard indicators were used for the sovereign 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 the Rating European Sub-Sovereign Governments (28 June 2024) https://dbrs.morningstar.com/research/435130. 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 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, 2024 National budget, 2024 Programa do Governo, Spring economic forecast from European Commission, Instituto Nacional de Estatística (INE) and Direcao Regional de Estatística da Madeira (DREM) national statistical agency, central bank, Ministry of Finance, IMF, World Bank, Haver Analytics. 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 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 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/436814/.

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: June 15, 2018
Last Rating Date: January 26, 2024

DBRS Ratings GmbH, Sucursal en España
Paseo de la Castellana 81
Plantas 26 & 27 28046 Madrid, Spain
Tel. +34 (91) 903 6500

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
Tel. +49 (69) 8088 3500
Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

For more information on this credit or on this industry, visit dbrs.morningstar.com.