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19 Sep 2019
New York, September 19, 2019 -- Moody's Investors Service has confirmed the US Virgin Islands' Caa3 issuer rating, as well as the ratings on the territory's four liens of matching fund revenue bonds issued through the Virgin Islands Public Finance Authority: Senior Lien Bonds, Caa2; Subordinate Lien Bonds, Caa3; Subordinated Indenture (Diageo) Bonds, Caa3, and Subordinated Indenture (Cruzan) Bonds, Caa3. This action concludes the review of the ratings that we initiated on June 12 for lack of sufficient financial information. This action affects approximately $1.06 billion in outstanding matching fund debt. The outlook on these ratings is stable.
The conclusion of the rating review follows our determination that the available information is sufficient, at this time, to maintain the ratings. Audited financial statements for the fiscal year ending September 30, 2017, have been delayed due to the impact of the hurricanes in September 2017. The government recently provided unaudited financial results for fiscal 2017 and projected cash-basis results for fiscal years 2018 and 2019 are included in the government's proposed budget for fiscal 2020. We expect that audited financial statements for fiscal 2017 will be released shortly and that, going forward, audits for fiscal years 2018 and 2019 will be released on a more timely basis. Other important information that is updated regularly includes monthly and quarterly economic and revenue data.
The Caa3 issuer rating reflects a small and highly concentrated economy, government finances that have been severely strained, a very poorly funded pension system that is rapidly depleting its asset base, financial reporting and other governance challenges, and the government's loss of capital markets access since 2017. Despite some recent improvement in the government's liquidity and near-term financial position, the rating incorporates the risk that the reemergence of a significant structural deficit, combined with the expected insolvency of the Government Employees' Retirement System, will lead the government to restructure its debt.
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. The Caa2 and Caa3 ratings on the matching fund revenue bonds recognize that these pledged revenues are currently paid directly by the US Treasury to the trustee. But this mechanism has not been tested in a stress situation in which the government attempts to divert pledged revenue for general government purposes. In addition, the matching fund revenue bonds would likely be included in any attempt to restructure the government's debt.
The stable outlook reflects recent improvement in the government's liquidity and near-term financial position driven by the receipt of disaster assistance and loans from the US government, a surge in tax revenues associated with local reconstruction activities, and an increase in concession fees from the Limetree (formerly Hovensa) refinery facility.
FACTORS THAT COULD LEAD TO AN UPGRADE
- Maintenance of structural balances by the primary government over an extended period.
- Adoption of a credible plan to address the large unfunded pension liability.
FACTORS THAT COULD LEAD TO A DOWNGRADE
- Default on government debt or initiation of a debt restructuring.
- Erosion of the government's financial position and liquidity.
- For the matching fund bonds only, a decline in matching fund revenues and debt service coverage due to a drop in rum shipments by the two distilleries or a reduction by the US government of the excise tax rate.
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 of 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 1.2% from 2012 to 2017. Population decreased from 115,852 in 2008 to 96,815 in 2017, while employment fell from 49,589 to 42,418 over the same period. Visitor arrivals have recovered since the hurricanes but remain below historical levels.
Government finances have been severely strained. Revenues declined abruptly in fiscal 2008 and 2009 due to the recession and operating losses at the Hovensa refinery. Since then the government addressed the resulting operating deficits primarily with borrowings and one-time revenues. After failing to complete a 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 an interruption in tax revenues and added storm-related expenditures, further straining the government's financial position. While the receipt of grants and loans from the federal government in response to the hurricanes and a surge in tax revenues associated with local rebuilding efforts have provided some near-term relief, the general fund could return to structural imbalance in coming years.
The Virgin Islands' government employees' retirement system has an extremely large unfunded liability. As of September 30, 2017, the GAAP-basis net pension liability for the system was $4.4 billion. System assets are projected to be depleted by 2023 or sooner. Upon insolvency, projected contributions will cover only about half of projected benefits and expenses.
The principal methodology used in the long-term issuer rating was US States and Territories published in April 2018. The principal methodology used in the matching fund revenue bond ratings was US Public Finance Special Tax Methodology published in July 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
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Please see www.moodys.com for any updates on changes to
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