Oct 24 - Fitch Ratings assigns a 'BBB' rating to $279.66 million U.S. Virgin
Islands (USVI) Public Finance Authority (VIPFA) bonds (Virgin Islands gross
receipts tax (GRT) loan note) consisting of:
--$195.995 million revenue refunding bonds, series 2012A (Working Capital
--$31.19 million revenue bonds, series 2012B (Capital Projects/Federally
--$52.475 million revenue bonds, series 2012C (Capital Projects/Tax Exempt).
The bonds are expected to sell via negotiation on Oct. 31, 2012.
Additionally, Fitch affirms the following ratings:
--USVI implied general obligation (GO) bond rating of 'BB'. There are no
outstanding stand-alone GO bonds of the USVI.
--$517.2 million in outstanding VIPFA gross receipts revenue bonds at 'BBB'.
The Rating Outlook for both ratings is Negative.
The GRT revenue bonds issued by VIPFA are secured by a pledge of GRT collections
from the USVI deposited to the trustee for bondholders prior to their use for
general purposes. The bonds also carry a GO pledge of the USVI.
KEY RATING DRIVERS
GRT SECURITY INSULATED FROM GOVERNMENT OPERATIONS: Bonds issued by VIPFA and
secured by the GRT are fairly insulated from general fund operations and debt
service coverage remains significant, even through stress scenarios. However,
the severity of expected declines in the GRT due to the loss of Hovensa,
previously a large oil refiner located on St. Croix and the largest employer and
taxpayer on the USVI, is unknown despite some offset provided by recent
increases in the GRT rate. Also, leveraging of the GRT to support general fund
operations, if necessary, could weaken projected coverage.
ECONOMIC AND FINANCIAL STRAIN: The below investment-grade implied GO rating and
Negative Outlook on both the GRT and implied GO ratings reflect significantly
strained fiscal operations, despite recent initiatives to structurally balance
the operating budget, and the intractability of longer-term fiscal challenges
that are now compounded by severe economic difficulties from the closure of
WEAKENED FINANCIAL POSITION: Longstanding fiscal challenges worsened in the
recent downturn with sharp revenue declines, prolonged, unresolved property tax
litigation, high fixed-cost burdens, and difficulty in reducing expenditures.
The territory has relied on borrowing to close both its operating gaps and
HOVENZA CLOSURE EXACERBATES CHALLENGES: The inability to close the budget gap in
fiscal 2012 is expected to be compounded in fiscal 2013 by additional revenue
losses associated with the closure of Hovensa, completed in February 2012. Given
recent tax rate increases and employee layoffs as well as a history of
difficulty in reducing expenditures, Fitch believes future budgeting balancing
options will be limited.
HIGH LONG-TERM LIABILITIES: Net tax-supported debt is extremely high, and
dedication of revenues to debt service reduces fiscal flexibility. Other
liabilities for pensions and unpaid retroactive salaries further weigh on the
territory's limited resources.
NARROW ECONOMY: The economy is limited, dependent on tourism and vulnerable to
disruption from natural disasters.
STABILITY FROM U.S. TERRITORY STATUS: Although the USVI enjoys less flexibility
in fiscal matters than U.S. states, the U.S. legal and regulatory environment
provides stability through some oversight of financial operations as well as the
allocation of grant and operating revenue
WHAT COULD TRIGGER A DOWNGRADE
--A substantial reduction in GRT revenues or a significant leveraging of this
revenue source by the USVI that notably reduces debt service coverage ratios
could lead to negative rating action on the GRT bonds.
--Further erosion in the USVI's financial position and/or deterioration in the
USVI's economy due to the Hovensa closure, beyond current expectations, would
lead to negative rating action on the implied GO rating.
The assignment of a 'BBB' rating on the GRT bonds reflects the structure's legal
protections and significant coverage of debt service by pledged revenues. GRT
bonds are secured by the USVI's pledge of GRT revenues received or to be
received. All such collections are deposited daily to a special escrow account.
With the exception of a small required payment for housing, all revenues are
allocated daily to the trustee for the benefit of bondholders, only after which
are remaining receipts available for general purposes. The priority claim of
bondholders to GRT collections and other structural protections insulate
bondholders from the USVI's broader fiscal stress and support a rating level
that is higher than the GO rating.
Security features include an additional bonds test requiring 1.5x maximum annual
debt service (MADS) coverage by historical and prospective revenues, a debt
service reserve funded at MADS, and covenants precluding tax rate reductions or
the granting of excessive tax incentives. Additionally, should a 1.5x MADS
coverage level be reached in any 12-month period, the USVI has covenanted to
seek out additional revenue to pledge to the bonds. As with states, the USVI and
VIPFA are ineligible to file for protection under the U.S. Bankruptcy Code. Debt
service coverage on the bonds increased in fiscal 2011 (Oct. 1 fiscal year) from
fiscal 2010 due to an increase in the GRT rate from 4% to 4.5%, effective May 1,
2011. Coverage of senior lien bonds in fiscal 2011 is estimated at about 3.62x,
up from 3.36x.
A further increase in the GRT rate to 5%, effective March 1, 2012, is expected
to produce similar levels of debt service coverage in fiscal 2012 as in fiscal
2011 as the higher rate is expected to be offset by the economic retrenchment
produced by the Hovensa closure combined with increasing levels of debt service.
When including unrated, junior lien obligations, combined debt service coverage
is estimated at 3x in both fiscal years 2011 and 2012. Coverage of senior lien
MADS by estimated fiscal 2012 revenues is forecast at 2.64x; down slightly from
about 2.8x forecast earlier this year, reflecting the $131 million refinancing
of a line of credit secured by a subordinate lien of GRT with this senior lien
issue and the additional borrowing for capital projects. MADS coverage of all
GRT-secured debt is 2.63x based on estimated fiscal 2012 revenues.
The enacted budget for fiscal 2013 reflects the expected impact of the closing
of the Hovensa refinery on both the economy and revenues, including a 6% assumed
decline in GRT revenue. Fitch's stress scenario, assuming 5% annual declines
throughout the forecast period, results in still sufficient coverage of senior
lien obligations until fiscal 2030. The stress test scenario does not include
the issuance of additional debt secured by the GRT, notable in that Fitch
believes there is the potential for the USVI to leverage this revenue source for
additional deficit and capital borrowing in the coming fiscal years. This
concern is encompassed in the Negative Outlook on these bonds.
The USVI's implied GO 'BB' bond rating incorporates Fitch's view that the USVI
will continue to have difficulty achieving ongoing structural budget balance in
the context of revenue losses due to the loss of its largest taxpayer and
employer, longstanding fiscal constraints, including from unresolved property
tax litigation, high fixed costs, and very high liabilities. The USVI has had
limited flexibility in responding first to the economic downturn and now to an
operating budget that is out of balance. After relying primarily on substantial
external borrowing to address budget gaps, the government has made deep spending
cuts, including staffing reductions, and has increased the GRT rate to address
its structural budget gap.
Progress had been made in fiscal management under federal oversight, leading to
spending and debt control, upgraded internal systems, and improved financial
reporting. Some of this progress has recently stalled as audit reports are again
considerably late, with the fiscal 2010 audit now expected at the end of
USVI revenue collections are subject to significant volatility. After several
years of robust economic and revenue growth, general fund revenues plummeted in
the recession, with GAAP-basis fiscal 2009 falling 29% from fiscal 2008, to $483
million. Personal and corporate income taxes were sharply lower, and further
litigation delays limited property tax collections. The USVI issued a $100
million loan note that year to fund operating expenditures. Operations in fiscal
2010 were additionally aided by an allocation of federal stimulus funds as well
as further borrowing to cover its structural deficit; in fiscal 2010, the USVI
issued its $399 million series 2010 A & B working capital revenue bonds to
redeem the $100 million loan note outstanding from fiscal 2009, redeem a $100
million working capital loan note that had been issued during fiscal 2010, and
provide an additional $150 million in working capital for that fiscal year.
For fiscal 2011, appropriations continued to exceed projected revenues and the
governor sought substantial mid-year spending cuts and an increase in the GRT
rate to balance the budget. The GRT rate increase to 4.5% provided some budget
relief, an 8% salary rollback for certain USVI employees was implemented,
effective Aug. 1, 2011, and a retirement incentive for long-term employees was
offered, as means to balance the budget. The USVI has preliminarily estimated
total revenues of $861 million, inclusive of $123 million received through an
external bank line of credit, supporting $863 million in expenditures that year,
resulting in a $2.9 million operating deficit.
Following the enactment of the fiscal 2012 budget, the governor's office
forecast a $67.5 million operating deficit and called for immediate expenditure
reductions and revenue increases to balance the budget. Approximately 500
employees were terminated in December 2011, providing about $20 million in
savings, although negotiations on increasing the GRT rate stalled. Amidst budget
negotiations, in January 2012 Hovensa announced its imminent closure. The USVI
estimated a direct annual revenue loss of about $50 million ($30 million in
income tax losses and $17 million in lost GRT revenue) related to the closure in
addition to the loss of about 2,000 jobs.
Following Hovensa's announcement, the legislature approved the increase in the
GRT rate to offset the expected loss of GRT revenue from Hovensa and also
implemented other expenditure reductions. A remaining budget gap was closed
through proceeds from the issuance of a working capital matching fund-secured
bond issue in August 2012. Proceeds of $60 million were applied to the fiscal
2012 budget and it is planned that $35 million and $25 million will be applied
to the fiscal 2013 and fiscal 2014 budgets, respectively.
Increasing matching fund (excise tax) revenue is expected to be available to the
general fund related to production at a new rum facility owned by Diageo.
Matching fund revenue is only available to the general fund after debt service
payments on the USVI's matching fund revenue bonds have been made in full and
Fitch believes the USVI may choose to further leverage this revenue source for
working capital and capital projects. The USVI estimates that a $9 million
budget gap exists in the recently enacted fiscal 2013 budget; however, Fitch
believes the budget gap could prove significantly larger given optimistic
projections for income tax receipts.
The USVI's liabilities are extremely high. Tax-supported debt totals about $2
billion as of Nov. 1, 2012, equivalent to 75% of personal income. About $735
million is GRT bonds, subordinate notes and tax increment revenue bond
anticipation notes (BANs) issued by VIPFA, which also carry a USVI GO pledge.
Another $1.3 billion is backed by matching funds from federal excise taxes
levied on USVI-distilled rum. In 2012, debt service for GRT bonds and matching
fund bonds totaled about $139 million, equal to 18.8% of general fund taxes and
gross matching fund receipts combined. Amortization is slow, with 30% maturing
in 10 years.
Persistent underfunding has led to a large pension liability, with an estimated
funding ratio of 49.9% as of Sept. 30. 2010, down from 52.4% the year prior; the
$1.5 billion unfunded liability equates to about 56% of 2010 personal income.
Other liabilities include negotiated but unpaid salary increases over the last
two decades, the burden of which was estimated at $232 million as of Sept. 30,
2009. In October 2010, the USVI shifted $45 million from its insurance guarantee
fund to repay a portion of the unpaid salaries. The USVI's liability for other
post-employment benefits totals $1.12 billion as of Sept. 30, 2010.
The USVI is an organized, unincorporated U.S. territory 40 miles east of the
Commonwealth of Puerto Rico. The economy is small, narrow and subject to
considerable volatility, although some diversification is underway. Tourism and
related industries represent approximately 80% of economic activity, although
other activities, notably rum distillation are prominent, and government
employment equals more than a quarter of jobs. Prior to its closure and
conversion to a storage facility in February 2012, Hovensa employed 2,000 on the
island of St. Croix, about 4.5% of total USVI employment, and was significant to
the USVI's economic activity and fiscal stability. Hovensa is expected to
continue to provide about 100 jobs on St. Croix; the USVI relates that a large
share of Hovensa's former employees are ex-patriots and are likely to leave the
USVI. The closure of the facility has contributed to the unemployment rate in
the USVI escalating to 13.2% in August 2012 as compared to 9.3% one year prior.
Tourism indicators have begun to stabilize after sharp, recession-related
declines in 2008 and 2009, although the economic recovery appears to be unsteady
and further improvement will be linked to broader economic trends in the U.S.,
from which the majority of USVI visitors originate. Following the recession,
2010 employment rose 1.1% in the USVI, compared with a 0.7% decline nationally.
In 2011, employment results were less positive, with a 0.7% decline compared to
1.1% growth in the U.S. More recent employment performance is weak with August
2012 down 6.6% from August 2011, compared to growth of 1.4% nationally over the