Fitch Rates $280MM U.S. Virgin Islands GRT Bonds 'BBB'; Affs Implied GOs at 'BB'; Outlook Negative
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 Refinancing/Tax Exempt);
--$31.19 million revenue bonds, series 2012B (Capital Projects/Federally Taxable);
--$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 Hovensa.
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 maintain liquidity.
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 November 2012.
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 same period.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria
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