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Global Credit Research - 31 Jan 2018
New York, January 31, 2018 -- Moody's Investors Service has assigned an Issuer Rating of Caa3, with a negative outlook, to the government of the US Virgin Islands. The Issuer Rating is equivalent to the rating we would assign to general obligation debt of the government. It serves as a reference point for the ratings on the territory's special tax and enterprise revenue debt.
We have also lowered the ratings on: the US Virgin Islands' Senior Lien Matching Fund Revenue Bonds to Caa2 from Caa1; its Subordinate Lien Matching Fund Revenue Bonds to Caa3 from Caa1; and its third lien Matching Fund Revenue Bonds, Subordinated Indenture (Diageo) and Matching Fund Revenue Bonds, Subordinated Indenture (Cruzan) to Caa3 from Caa2. The outlook on all four liens of matching fund revenue bonds is negative. These actions conclude our review of the ratings on the matching fund revenue bonds.
The Issuer Rating of Caa3 reflects the territory's extremely weak economic, financial and liquidity condition, which has been made worse by the effects of Hurricanes Irma and Maria. While assistance from the federal government in response to the hurricanes has provided some near-term relief, we believe the severity of the territory's fundamental fiscal and cash challenges, combined with the pending insolvency of the territory's government employees' retirement system, make a debt restructuring highly likely.
The Caa2 and Caa3 on the four liens of matching fund revenue bonds ratings reflect our expectation that the matching fund bonds will inevitably be included in any debt restructuring. The one notch distinction between the rating on the senior lien matching fund bonds and the Issuer Rating reflects structural features currently in place for the matching fund bonds which provide some protections to bondholders in the short term, but which are unlikely to survive a restructuring. Debt service is funded one year in advance, with matching fund revenues currently paid directly to the bond trustee by the US Treasury. This mechanism, however, has not been tested in a stress situation in which the government attempts to divert pledged revenue for general government purposes.
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 high likelihood 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.
- Adoption of a credible plan to address the territory's extremely large unfunded pension liability.
FACTORS THAT COULD LEAD TO A DOWNGRADE
- Default on government debt and/or initiation of a debt restructuring.
- Further erosion of the government's financial position and liquidity.
- Decline in matching fund revenues and debt service coverage due to reduction in rum shipments by the two distilleries.
The Issuer Rating is equivalent to the rating we would assign to general obligation debt of the government. The matching fund revenue bonds are secured by remittances to the Virgin Islands government from the US government of excise taxes collected on rum produced in the territory and exported to the US. Security for the matching fund bonds 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.
The territory's economy was in decline prior to the hurricanes in September 2017. As a result of the closure of the Hovensa oil refinery in 2012 and weak performance in the tourism sector, nominal GDP declined at a compounded annual rate of 1.8% from 2011 to 2016. Population fell from 115,852 in 2008 to 103,190 in 2016, while employment fell from 49,590 to 43,186 over the same period. Unemployment in 2016 was 11.1%, more than twice the US levels. GDP per capita in 2016 was $36,982, 64.3% of the US level. The hurricanes have disrupted the islands' tourism industry which may take two to three years to recover.
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. Since then the government addressed the resulting deficits primarily with deficit financings and one-time revenues. After failing to complete another deficit financing in January 2017, the government's financial position and liquidity deteriorated rapidly despite the enactment of some limited tax increases in February. The hurricanes resulted in a severe decline in tax revenues, further straining the government's financial position. While the receipt of grants and loans from the federal government in response to the hurricanes has provided some near-term relief, the general fund still has a large structural deficit and liquidity remains very weak.
The Virgin Islands' government employees retirement system has an extremely large unfunded liability. As of September 30, 2016, the GAAP-basis net pension liability for the system was $4.6 billion. System assets were projected to be depleted by 2023, but this will likely happen much sooner because, among other factors, the government has been deferring its statutorily-required contributions.
The principal methodologies used in these ratings were US Public Finance Special Tax Methodology published in July 2017 and 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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