TEXT-S&P affirms Newfoundland and Labrador at 'A+/A-1+'
Overview -- The Province of Newfoundland and Labrador continues to have a strong economy and strong financial management, in our view. -- We are affirming our 'A+/A-1+' long- and short-term issuer credit ratings on Newfoundland and Labrador. -- We are also affirming our 'A+/A-1+' senior unsecured debt and short-term issuer credit ratings on Newfoundland and Labrador Hydro, both of which are based on the province's guarantee. -- The stable outlook reflects our view that Newfoundland's economy will continue to have elevated capital investment-related major resource developments during our two-year rating horizon. Rating Action On Nov. 20, 2012, Standard & Poor's Ratings Services affirmed its 'A+' long-term and 'A-1+' short-term issuer credit ratings on the Province of Newfoundland and Labrador. At the same time, we affirmed our 'A+' senior unsecured debt and 'A-1+' short-term issuer credit ratings on Newfoundland and Labrador Hydro, both of which are based on the province's guarantee. The outlook is stable. Rationale The ratings on the Province of Newfoundland and Labrador reflect Standard & Poor's view of the province's strong economy, positive financial management, low debt burden, and very positive liquidity. Its moderating budgetary performance and risks related to the Lower Churchill hydroelectric project constrain the ratings, in our view. Newfoundland's vibrant resource-based economy supports our assessment of the ratings. Its large and active offshore oil and mining sectors contribute strongly to its high wealth, with nominal GDP per capita of approximately C$50,000 (by our estimate). The province's resource industries, especially offshore oil, also pay large extraction royalties that have given it strong internal financing capacity to pay down debt, improve tax competitiveness and make strategic capital investments. However, Newfoundland's resource production represents slightly over 40% of GDP, leaving economic output subject to commodity price volatility and individual project operating risks. Provincial revenues are also sensitive to changes in resource production values, with royalties accounting for an estimated 40% of the province's adjusted operating revenues in fiscal 2012. Nevertheless, under our base case scenario, we expect Newfoundland's economy to benefit from sustained high capital investment in the next two years, largely thanks to construction of the Hebron offshore oil project and Lower Churchill. We expect these to generate further steady improvement in employment that will support provincial taxation revenues. Newfoundland's positive financial management under our criteria also supports the ratings. In our view, the province possesses several attributes that mitigate the potential downside effect of its high fiscal dependence on resource royalties. Chief among them are its accumulation of large cash balances, which are available as a potential fiscal stabilizer. The province has also chosen to allocate past operating surpluses primarily to non-recurring capital investments, as opposed to base budget increases. We expect its conservative management practices to continue in the next two years. The province also has the third lowest debt burden among Canadian provinces. We estimate its tax-supported debt at about 75% of operating revenues in fiscal 2012 (year ended March 31), down from 180% in fiscal 2005. It has not issued debt in five years. However, we expect it to return to the debt markets in the next several years, although the timing and magnitude of its borrowing will depend on its cash flow generation, preferred minimum cash balances, and Lower Churchill's financing strategy. We consider Newfoundland's moderating budgetary performance due to the end of 1985 Atlantic Accord payments and lower royalties to be a ratings constraint. Under our base case scenario, we expect the province's operating surplus to average approximately 4% of adjusted operating revenues from fiscal years 2013-2015, compared with an estimated average of 15% from fiscal 2010-2012. We also expect its after-capital account balance to swing to deficit, averaging approximately 8% of adjusted total revenues. Newfoundland's potential funding requirements and contingent liabilities related to Lower Churchill also constrains the ratings. Although the decision to proceed with the project bodes well for the economy, it could expose the province to substantial construction risk and borrowing requirements in the next several years. We understand the province and its energy subsidiary, Nalcor Energy, will fund C$6.2 billion of the project's estimated construction costs, while Emera Inc. will fund C$1.2 billion. We also understand the project's financing strategy is not finalized, nor is the planned funding contribution, although the federal government has agreed to provide some form of loan guarantee. Outlook The stable outlook reflects our view that Newfoundland's economy will continue to have elevated capital investment related major resource developments during our two-year rating horizon, supporting employment and provincial tax revenues. Under our base case scenario, we assume the province will need to make significant capital expenditures and investments that will lead to moderate after-capital deficits in the next two years. We expect this, along with the province's reduced internal financing capacity due to smaller operating surpluses, to require the province to draw on its liquidity and potentially issue new debt. However, we expect Newfoundland to keep free cash and liquid investments above 80% of the next 12 months' debt service, and tax-supported debt below 120% of operating revenues in the next two years. We would raise the ratings if, all else being equal, we foresaw a material reduction in potential contingent liabilities, which we do not expect until after Lower Churchill's transition to operation, coupled with significantly reduced pension deficiencies and stronger-than-expected budgetary results. Conversely, we could lower the ratings if we came to expect sustained deterioration in economic prospects or liquidity, or significantly increased contingent liabilities associated with Lower Churchill. Currently, we have no visibility of such developments in either direction. Related Criteria And Research Methodology For Rating International Local And Regional Governments, Sept. 20, 2010 Ratings List Ratings Affirmed Newfoundland and Labrador (Province of) Issuer Credit Rating A+/Stable/A-1+ Senior Unsecured AA- Senior Unsecured A+ Commercial Paper Global scale A-1+ National scale A-1(HIGH) Newfoundland and Labrador Hydro Senior Unsecured A+ Commercial Paper Global scale A-1+ National scale A-1(HIGH) Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.