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24 Jan 2017
New York, January 24, 2017 -- Summary Rating Rationale
Moody's Investors Service has downgraded the ratings on the US Virgin Islands' four liens of Matching Fund Revenue Bonds, issued through the Virgin Islands Public Finance Authority, as follows: Senior Lien Bonds to Caa1 from B1; Subordinate Lien Bonds to Caa1 from B1; Subordinated Indenture (Diageo) Bonds to Caa2 from B2; and Subordinated Indenture (Cruzan) Bonds to Caa2 from B2. The bonds are secured by matching fund revenues which are remittances paid by the federal government to the Virgin Islands' government of a portion of federal excise taxes collected on rum produced in the territory and shipped to the US mainland. The rating action affects approximately $1.16 billion in outstanding debt.
The downgrades are triggered by the territory's extremely weak financial position and liquidity, its apparent failure to access the capital markets for a planned deficit financing which would have balanced the current year budget and bolstered liquidity levels, and an increased possibility that the government may be forced to restructure its debt to address its financial problems. Key characteristics of the government's general credit profile include: persistent general fund deficits addressed primarily with repeated deficit financings; very high debt levels; declining gross domestic product and population; and a high unemployment. The Virgin Islands' government has an extremely large unfunded pension liability and the retirement system is projected to become insolvent by fiscal 2023.
The ratings recognize a number of structural features that provide bondholder protections and stronger credit quality than unsecured general obligation bonds, most notably the direct payment of pledged revenues by the US Treasury to the special escrow agent/trustee. The government recently acted to strengthen the direct payment mechanism by making the instruction to the federal government permanent and irrevocable. The government has pledged and assigned matching fund revenues to the trustee for the benefit of bondholders, establishing a security interest in the revenues. The statutes are written to create a statutory lien on the revenues. We note, however, that these security provisions have not been tested in a stress scenario where the government faces a severe lack of funds to provide basic services and we believe they do not protect bondholders in the event that the government is forced to restructure its debt.
The outlook on the ratings is negative, reflecting the severe fiscal challenges facing the government, the possibility that its liquidity and general credit profile could continue to deteriorate, and the increased possibility that the government may be forced to restructure its debt to address its financial problems.
Factors that Could Lead to an Upgrade
Restoration and maintenance of structural budget balance by the primary government.
Factors that Could Lead to a Downgrade
Further erosion of the government's financial position and liquidity.
Decline in matching fund revenues and debt service coverage due to further reduction in rum shipments by the two distilleries.
Bond security is established by the trust indenture, the loan agreement, the special escrow agreement, and Virgin Islands statutes. The government has pledged and assigned matching fund revenues to the trustee for the benefit of bondholders, establishing a security interest in the revenues. The statutes are written to create a statutory lien on the revenues. In the loan agreement the government covenants to direct the US Treasury to pay the pledged matching fund revenues directly to the trustee. This structure provides apparent bondholder protections and stronger credit quality than unsecured general obligation bonds, but it has not been tested in a severe stress scenario.
Use of Proceeds
With the closure of the Hovensa oil refinery in 2012, the territory's economy is primarily concentrated in tourism. While there have been some positive trends in visitor counts since the recession, GDP continues to decline, dropping at a compounded annual rate of 2.7% from 2009 to 2014. Population fell from 115,852 in 2008 to 103,450 in 2015, while employment fell from 49,677 to 43,024 over the same period. Unemployment at 11.9% in 2015 was more than twice the US levels. Per capita personal income in 2014 was 47.6% of the US level.
Government finances have been severely strained. Revenues fell abruptly in fiscal 2008 and 2009 as a result of the recession and operating losses at the Hovensa refinery. The government addressed the resulting deficits primarily with deficit financings. Revenues have recovered somewhat in recent years. The Hovensa refinery was recently sold generating a $220 million one-time payment which benefited government finances and liquidity in fiscal 2016. Nevertheless, the general fund still has a structural deficit.
The principal methodology used in this rating was US Public Finance Special Tax Methodology published in January 2014. An additional methodology used in this rating was US States Rating Methodology published in April 2013. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
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