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Rating Action:

Moody's Downgrades Newfoundland and Labrador's Debt Ratings to Aa3, Outlook Remains Negative

21 Jul 2016

Toronto, July 21, 2016 -- Moody's Investors Service today downgraded the long-term debt ratings of the Province of Newfoundland and Labrador to Aa3, from Aa2, along with the senior unsecured shelf to (P)Aa3, from (P)Aa2. . The outlook on the ratings remains negative.

RATINGS RATIONALE

The principal driver of the downgrade to Aa3 from Aa2 is the weak fiscal forecast the province faces over the medium-term and resulting increase in debt burden and interest expense. The province is facing deep deficits caused by the significant decline in the price of oil starting in mid-2014. Newfoundland and Labrador is expected to have posted a very high deficit of CAD2.2 billion (37.3% of revenue) in 2015/16, and has budgeted for deficits of CAD1.8 billion (27.0% of revenue) and CAD1.1 billion (14.3% of revenue) in 2016/17 and 2017/18 respectively.

To finance the anticipated deficits, Moody's forecasts that the province's net direct and indirect debt, relative to revenues, will approach 240% by 2020/21, the highest forecasted level of Canadian provinces. Moody's notes that this includes CAD4.5 billion of promissory notes the province has issued to fund its pension liabilities. Moody's expects the province's interest expense to reach 12% of revenues by 2020, a high level compared to international peers and a level not seen by the province since 2004.

Although the province has aggressively moved to introduce revenue measures, including a two percentage point increase to the provincial portion of the harmonized sales tax, increases to income taxes and the introduction of a temporary Deficit Reduction Levy, the increase in revenues is insufficient to offset the CAD1.6 billion decrease in the level of annual oil royalties between 2013/14 and 2015/16. Despite oil prices strengthening since their January 2016 lows of roughly USD30/bbl, oil prices are expected to remain well below the high prices recorded in 2013-2014 across the medium-term, thereby continuing to dampen the level of offshore royalties the province is expected to record.

Once the province has fully implemented the new revenues measures contained in Budget 2016, Moody's expects revenue growth to average 2.2% across the period 2018/19-2022/23, a modest growth rate which will assist only marginally to reduce the expected deficits across these years.

Furthermore, economic activity shows signs of decline, with reductions in private sector investment forecasted over the medium-term. Although oil production is expected to rise as new wells are exploited, economic activity overall is expected to stagnate, leading to higher unemployment across the province which will put downward pressure on revenues generated through income and sales taxes.

RATIONALE FOR THE NEGATIVE OUTLOOK

The negative outlook reflects the execution risk the province faces in achieving its budget targets, which could lead to further fiscal deterioration from lower than anticipated deficit reduction or higher than expected debt accumulation. Moody's notes that the 2016 provincial budget plan, which if successful would still see deficits through 2022/23, outlines a very aggressive response to the fiscal challenges facing the province. To achieve the province's target of fiscal balance by 2021/22 will require even greater measures. Among the risks Moody's sees is the province's commitment to keep program expenditure growth essentially flat across the 7 year horizon, viewed as an ambitious target given the pressures stemming from certain departments such as health care which must cope with an aging population.

The negative outlook also reflects the forecast that Newfoundland and Labrador will have fully exploited its fiscal flexibility across the medium-term, once the budget plan is fully exercised. The province therefore faces increased risk that it will be unable to react to further downward pressures should these pressures arise.

What Could Change the Rating Up/Down

The outlook could be revised to stable if the province is able to implement and achieve the required revenue and expenditure targets and demonstrate an ability to restrict debt accumulation as planned. The rating could face downward pressure if the province fails to achieve its budgetary targets, resulting in higher and more persistent fiscal deficits than planned. Downward pressure may also result if signals emerge that debt accumulation will be higher than currently planned.

The principal methodology used in these ratings was Regional and Local Governments published in January 2013. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.

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Michael Yake
Vice President - Senior Analyst
Sub-Sovereign Group
Moody's Canada Inc.
70 York Street
Suite 1400
Toronto, ON M5J 1S9
Canada
(416) 214-1635

David Rubinoff
MD - Sub-Sovereigns
Sub-Sovereign Group
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