Territory’s Matching Fund And Gross Receipt Tax Bonds Downgraded By Standard & Poor’s

U.S. Virgin Islands bonds continue be battered by top ratings firms, with Standard and Poor’s Global Ratings joining the chorus on Thursday by lowering the territory’s matching fund (rum cover-over) and Gross Receipt Tax (GRT) bonds, citing declining coverage and weak fiscal conditions as the reason for downgrading the former, and deteriorating economic and fiscal conditions for the latter.

S&P Global Ratings downgraded the Virgin Islands Public Finance Authority’s (PFA) senior-lien matching fund notes to ‘BB’ from ‘BBB’ and has lowered its rating on subordinate-lien matching fund notes, issued for the territory, to ‘BB-‘ from ‘BBB-‘. At the same time, S&P Global Ratings has assigned its ‘BB’ long-term rating to PFA’s series 2016A senior-lien capital projects and working capital notes and its ‘BB-‘ to its series 2016B subordinate-lien working capital notes issued for the territory.

“The downgrade reflects weakened economic conditions, declining coverage and revenue trends, and continued reliance on this revenue source to finance operating deficits,” said S&P Global Ratings credit analyst John Sugden. “It also reflects our view of a closer linkage between the territory’s general fiscal condition and the repayment of the bonds, especially during times of significant fiscal distress.”

S&P Global said matching fund bonds outlook is negative, which reflects its view that the continued significant economic, financial, and budgetary challenges the territory currently faces, absent corrective action, could lead to increased deficit financing and, over time, inadequate capacity or willingness to meet its financial commitment to its obligations, especially if market access becomes constrained.

GRT notes were downgraded seven notches from BBB+ to B. The ratings firm said the downgrade reflects weak economic conditions, declining coverage, and the potential for further coverage dilution based on the need to issue additional debt to fund capital and cover operating deficits. It also reflects S&P Global’s view of a closer linkage between the territory’s general fiscal condition and the repayment of the bonds, especially during times of significant fiscal distress.

“In our view, the USVI faces significant economic, financial, and budgetary challenges, which we believe could lead to inadequate capacity to meet its financial commitment to the obligations,” Mr. Sugden said. S&P Global also gave GRT notes a negative outlook, with its reasons being similar to that of the matching funds bond downgrade.

The downgrades comes on the heels of the Juan F. Luis Hospital’s crisis. The medical facility was warned by CMS that it would face decertification if it did not come into compliance with CMS standards for participation by December 9. CMS further stated that it would end its current agreement with JFL by February 27 if the hospital does not comply. Governor Kenneth Mapp has asked the Senate to swiftly move on his $260 million capital projects measure, and requested that lawmakers increase the line item for hospital repairs from $10 million to $20 million. In November, the governor signed into law a $247 million working capital bill, $147 million of which was to be used for government operations, including $25 million for the territory’s hospitals.

“The negative outlook reflects our view that although coverage remains adequate, there are significant pressures that could lead to higher leverage, declining revenues, or both. To the extent that the USVI continues to face significant fiscal pressures, we believe significant additional deficit financing is likely,” S&P said. “In our view, if the territory does not take definitive action to address its current fiscal position, we could see further deterioration in credit quality, especially if we view the USVI’s capacity or willingness to pay debt service on the bonds as compromised. Depending on the magnitude of the fiscal distress, we could lower our rating by one or more notches over the one-year outlook horizon. We could also lower our rating by one or more notches should we believe that revenue flows are being disrupted.”

The GRT’s ‘B’ rating, according to S&P Global, reflects:

• The government’s fiscal distress, as evidenced by its significant structural imbalance and continued reliance on deficit financing to fund operations, weak financial reporting, significantly underfunded pension liabilities, and negative fund balances, which could translate into increased debt issuance and, ultimately, impair the government’s ability or willingness to pay debt service on the bonds, especially in the absence of market access or bonding capacity;
• Pledged revenues that have exhibited either declining or flat growth absent tax rate increases and are levied on a limited and concentrated base;
• Adequate, but substantially reduced, debt service coverage, due to flat revenues and rising debt service, which could continue to decline based on additional issuance, a weaker economy, or tax base erosion due to increased exemptions to promote economic development;
• Limited economy, concentrated in rum production, tourism, and government that has experienced significant losses following the recession and the 2012 closure of the Hovensa oil refinery, one of its largest employers, and that could be negatively affected by competitive, environmental, or fiscal factors.

Offsetting factors, according to S&P Global, include:

• A five-year fiscal recovery plan, which if implemented, could begin to address some of the USVI’s long-term structural challenges;
• The potential for growing employment following the new operating agreement with Limetree Bay Terminals LLC.

The ‘BB’ rating on the senior-lien matching fund bonds reflects S&P Global’s view of the following weaknesses:

• The government’s fiscal distress, as evidenced by its significant structural imbalance and continued reliance on debt issuance to fund operations, weak financial reporting, significantly underfunded pension liabilities, and negative fund balances, which could translate into continued bonding to fund operating deficits and, in the absence of market access or bonding capacity; impaired ability or willingness to pay debt service on the bonds;
• Adequate, but declining debt service coverage, which could continue to decline based on additional issuance or declines in rum sales;
• The need for annual gubernatorial instructions to the U.S. Treasury DOI for payment to the special escrow agent as well as regular U.S. federal legislative approvals to maintain the current $13.25 transfer rate, which could at times translate into lower or delayed revenues;
• Narrow and concentrated base of tax generators with two companies, Diageo and Cruzan, generating all revenues;
• Industry, environmental, and business risks to the major production facilities on the island; and
• Limited financial flexibility as evidenced by the need to structure debt service relying on capitalized interest to absorb increased debt service costs and back-loaded debt service schedule.

These weaknesses are somewhat offset by S&P Global’s view of:

• The lockbox flow of funds in which the pledged revenues are deposited directly by the U.S. Treasury into a special escrow account held by the special escrow agent;
• The authority’s adequate senior-lien maximum annual debt service coverage: 2.43x based on $187 million collected in fiscal 2015; and
• Adequate bond provisions that include a fully funded debt service reserve and a multipart additional bonds test (ABT).