News Column

Fitch Rates $122MM U.S. Virgin Islands GRT Bonds 'BBB'; Implied GO Downgraded; Outlooks Negative

June 10, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has assigned a 'BBB' rating to $121.545 millionU.S. Virgin Islands (USVI) Public Finance Authority (VIPFA) bonds (Virgin Islands gross receipts taxes [GRT] loan note) consisting of the following:

--$60.77 million series 2014A (Capital Projects);

--$60.775 million series 2014B (Working Capital).

The bonds are expected to sell via negotiation the week of June 16, 2014.

Additionally, Fitch takes the following actions on the ratings of the USVI:

--$696.9 million in outstanding USVI VIPFA GRT bonds are affirmed at 'BBB';

--Implied general obligation (GO) bond for the USVI downgraded to 'BB-' from 'BB'. There are no outstanding stand-alone GO bonds of the USVI.

The Rating Outlooks remain Negative.

SECURITY

The GRT revenue bonds issued by VIPFA are secured by a pledge of GRT collections from the USVI deposited to the trustee for bondholders prior to their use for general purposes. The bonds also carry a GO pledge of the USVI.

KEY RATING DRIVERS

GRT SECURITY INSULATED FROM GOVERNMENT OPERATIONS: Bonds issued by the VIPFA and secured by the GRT have been insulated from general fund operations through a collection process that allocates pledged revenues to a separate escrow account. Debt service coverage remains satisfactory although it will be reduced by debt service associated with the current issue combined with expected weak future revenue trends. The Negative Outlook on the GRT bonds reflects the weak USVI economy and concern that the USVI will over-leverage this revenue source.

ECONOMIC AND FINANCIAL STRAIN RESULT IN IMPLIED GO DOWNGRADE: The downgrade of the implied GO rating to 'BB-' from 'BB' and maintenance of the Negative Outlook reflect severely strained fiscal operations and the intractability of longer-term fiscal challenges that are compounded by acute economic difficulties.

WEAK FINANCIAL POSITION: Longstanding fiscal challenges worsened in the recent downturn with sharp revenue declines, prolonged, unresolved property tax litigation, high fixed-cost burdens, and difficulty in reducing expenditures. These fiscal challenges were compounded by the closure of Hovensa, the USVI's former largest employer and taxpayer. The territory has relied on borrowing to both close its operating gaps and maintain liquidity, and financial operations are expected to remain structurally imbalanced for the next several fiscal years. Fitch believes future budgeting options are limited.

HIGH DEBT AND LIABILITY BURDEN: Net tax-supported debt is extremely high, and dedication of revenues to debt service reduces fiscal flexibility. Other liabilities for pensions and unpaid retroactive salaries further weigh on the territory's limited resources.

NARROW ECONOMY: The economy is limited, dependent on tourism and vulnerable to disruption from natural disasters.

STABILITY FROM U.S. TERRITORY STATUS: Although the USVI enjoys less flexibility in fiscal matters than U.S. states, the U.S. legal and regulatory environment provides some stability.

RATING SENSITIVITIES

--FOR THE GRT BONDS: A reduction in expectations for GRT revenues; leveraging that notably reduces debt service coverage ratios; further economic erosion in the USVI.

--FOR THE IMPLIED GO RATING: Further erosion in the USVI's financial position and/or deterioration in the USVI's economy; continued issuance of working capital borrowing for operations; failure to stabilize pension funding.

CREDIT PROFILE

The 'BBB' rating on the GRT bonds reflects the structure's legal protections and satisfactory coverage of debt service by pledged revenues. GRT bonds are secured by the USVI's pledge of GRT revenues with all collections deposited daily to a special escrow account. With the exception of a small required payment for housing, all revenues are allocated to the trustee for the benefit of bondholders, only after which are remaining receipts available for general purposes. The priority claim of bondholders to GRT collections and other structural protections insulate bondholders from the USVI's broader fiscal stress and support a rating level that is higher than the GO rating.

The downgrade of the implied GO rating to 'BB-' from 'BB' incorporates the significant financial and economic pressures faced by the USVI. A severely unbalanced operating budget has led to multiple years of borrowing to fund ongoing operations and reported operating deficits; $30 million of proceeds from the current issue are providing a second round of working capital for the fiscal 2014 budget. Budget imbalance is expected to remain over the next several fiscal years as the USVI has been unable to adjust its expenditures to incorporate a reduced revenue structure. The economy is limited and unemployment rates have escalated following the large layoffs related to the Hovensa closure in 2012.

COVERAGE OF GROSS RECEIPTS TAX BONDS REMAINS SATISFACTORY

The USVI increased the GRT tax rate to 5% from 4.5%, effective March 1, 2012, in response to its fiscal difficulties in the fiscal year ending Sept. 30, 2012 as well as the announced closure in January 2012 of Hovensa, the USVI's former largest employer and taxpayer. The increase in rate was expected to be offset by the economic retrenchment produced by the Hovensa closure combined with increasing levels of debt service. Positively, cash-basis collections in fiscal 2012 that are certified by Ernst & Young showed 3.5% growth from fiscal 2011, providing for continued strong coverage on outstanding bonds. For fiscal 2013, the first full fiscal year of collections at the higher GRT tax rate, cash-basis collections exhibited 1.7% growth to $153.2 million.

Senior lien debt service coverage from fiscal 2013 cash collections was 3.57x; when including unrated, junior lien obligations, combined debt service coverage was 3.33x that year. Coverage of maximum annual debt service (MADS) on all GRT-secured debt was 2.67x by fiscal 2013 revenues. The USVI is forecasting 1.9% growth in GRT collections for fiscal 2014 although collections through the first two quarters of the fiscal year are down year-over-year (yoy) by 7.3%. Fitch estimates that a 7.3% decline in fiscal 2014 revenues would produce still solid annual debt service coverage on senior lien debt in fiscal 2014 of 2.79x while coverage of all-GRT debt would approximate 2.5x. Coverage of MADS from the Fitch-adjusted fiscal 2014 forecast indicate a MADS coverage level of about 2.19x.

Security features include an additional bonds test requiring 1.5x MADS coverage by historical and prospective revenues, a debt service reserve funded at MADS, and covenants precluding tax rate reductions or the granting of excessive tax incentives. Additionally, should a 1.5x MADS coverage level be reached in any 12-month period, the USVI has covenanted to seek out additional revenue to pledge to the bonds. With the rate increase to 5% in March 2012, the USVI amended the bond resolution to permit the GRT rate to fall back to 4.5% should corporate income tax (CIT) receipts reach $185 million in any fiscal year; CIT receipts are estimated at $63 million in fiscal 2013. The USVI and VIPFA are ineligible to file for protection under the U.S. Bankruptcy Code.

USVI FINANCIAL AND ECONOMIC CHALLENGES EXPECTED TO CONTINUE

The downgrade of the implied GO rating to 'BB-' incorporates Fitch's view that the USVI will continue to have difficulty achieving ongoing structural budget balance in the context of revenue losses due to longstanding fiscal constraints, high fixed costs, and very high liabilities, and the loss of its largest taxpayer and employer. The USVI has had limited flexibility in responding first to the economic downturn and now to an economy that is hampered by employment losses from the Hovensa closure and a tourism sector that is demonstrating uneven growth. Despite making deep spending cuts, including staffing reductions and an 8% across the board salary cut, as well as increasing the GRT rate to address its structural budget gap, the operating budget is significantly unbalanced. The USVI has also borrowed substantially for working capital, applying proceeds to financial operations in fiscal years 2009 through fiscal 2014; $30 million of the proceeds from the current issue is in addition to $25 million borrowed in 2012 to fund operations in the current fiscal year. Borrowing for deficit financing is now estimated to account for about 40% of all outstanding debt obligations, including bonds issued under the matching fund revenue program.

USVI revenue collections are subject to significant volatility. After several years of robust economic and revenue growth, general fund revenues plummeted in the recession, with GAAP-basis fiscal 2009 falling 29% from fiscal 2008, to $687.5 million, inclusive of borrowing for working capital and operating transfers. Personal and corporate income taxes were sharply lower, and further litigation delays limited property tax collections. The USVI issued a number of working capital loan notes during the recession and applied additional federal funding to operations.

For fiscal 2011, appropriations continued to exceed projected revenues and the governor sought substantial mid-year spending cuts and an increase in the GRT rate to balance the budget. The GRT rate increase to 4.5% provided some budget relief, an 8% salary rollback for certain USVI employees was implemented, effective Aug. 1, 2011, and a retirement incentive for long-term employees was offered, as means to balance the budget. Final audited revenues of $867.5 million in fiscal 2011, inclusive of $131 million received through external working capital borrowing and operating transfers, supported $847 million in expenditures that year, resulting in a $16.7 million GAAP-basis operating surplus. On a budgetary basis, the USVI reported a $2.9 million operating deficit.

Following the enactment of the fiscal 2012 budget, the governor's office forecast a $67.5 million operating deficit and called for immediate expenditure reductions and revenue increases to balance the budget. Approximately 400 employees were terminated in December 2011 and amidst budget negotiations, in January 2012, Hovensa announced its imminent closure. The USVI estimated a direct annual revenue loss of about $50 million ($30 million in income tax losses and $17 million in lost GRT revenue) related to the closure in addition to the loss of about 2,000 jobs.

Following Hovensa's announcement, the legislature approved the increase in the GRT rate to 5% to offset the expected loss of GRT revenue from Hovensa and also implemented other expenditure reductions, for a total in $125.7 million expenditure reduction from fiscal 2011. An external working capital matching fund-secured bond was issued in August 2012 to support financial operations in fiscal 2012 and the next two succeeding fiscal years. Proceeds of $55 million were applied to the fiscal 2012 budget, $35 million was to be applied to the fiscal 2013 budget, and the remaining $25 million was to be applied to the fiscal 2014 budget. Despite the actions taken by the USVI, reduced revenues and the carry-forward of structural budgetary imbalance resulted in an estimated $44.3 million budgetary operating deficit for fiscal 2012. The fiscal 2012 audit recorded a $94.3 million operating surplus for that year as the working capital matching fund bond boosted the USVI's cash position.

For the fiscal year ended Sept. 30, 2013, the USVI estimates $741.2 million in available general fund resources, including the $35 million in bond proceeds. Expenditures are estimated to have totaled $717.1 million, resulting in the USVI's estimate of a $24 million operating surplus. Movement toward budgetary balance was forestalled by the reinstatement on July 1 of full salary to employees impacted by the 8% salary reduction implemented in fiscal 2011. Budgetary operations have been aided by increasing matching fund (excise tax) revenue related to production at a new rum facility owned by Diageo. Matching fund revenue is only available to the general fund after debt service payments on the USVI's matching fund revenue bonds have been made in full.

The USVI expects operations in the current fiscal 2014, inclusive of the additional $30 million in working capital proceeds from the upcoming sale, to produce a $4.7 million operating surplus; however, $25 million in unspecified appropriation cuts are required prior to the fiscal year ending on Sept. 30, 2014 to achieve this target, which Fitch believes will be difficult to achieve. Fitch believes financial operations will continue to be strained by a multitude of spending pressures, including increasing employee health care costs, debt service expense, and the need to address the stability of the pension system. Fitch believes that future years' budgets will be additionally challenged in achieving structural balance as working capital proceeds have helped to support recent years' budgets.

LIMITED ECONOMY WITH HIGH UNEMPLOYMENT

The USVI is an organized, unincorporated U.S. territory with a population of 106,000. The economy is small, narrow and subject to considerable volatility. Tourism and related industries represent approximately 80% of economic activity, although other activities, notably rum distillation are prominent, and government employment equals more than a quarter of jobs. Prior to its closure and conversion to a storage facility in February 2012, Hovensa employed 2,000 on the island of St. Croix and was significant to the USVI's economic activity and fiscal stability. Due to the effects of the recession and the closure of Hovensa, the USVI estimates gross territorial product fell by 22% from 2008 to 2012. The closure of the facility has also contributed to the unemployment rate in the USVI escalating to 13.4% in 2013 from 8.9% in 2011, incorporating an 11% loss of total nonfarm employment between 2011 and 2013. The employment picture continues to be weak in 2014; a 12.8% unemployment rate was recorded for March 2014 compared to a 6.7% U.S. rate and total nonfarm employment declined by 2% in April 2014 compared to 1.7% national growth.

Tourism indicators have begun to stabilize after sharp, recession-related declines in 2008 and 2009, although the economic recovery appears to be unsteady and further improvement will be linked to broader economic trends in the U.S., from which the majority of USVI visitors originate. While cruise ship visitors to the USVI have recently increased, growing 4.9% between January 2012 and December 2013, air arrivals over the same period declined by 4.7% and hotel occupancy rates have remained just under 60% for the USVI as a whole.

DEBT AND UNFUNDED LIABILITIES ARE EXTREMELY HIGH

The USVI's liabilities are extremely high relative to U.S. states. Tax-supported debt totals about $2.1 billion as of June 1, 2014, estimated to be equivalent to 80% of personal income. About $796 million is GRT bonds, subordinate notes and tax increment revenue bond anticipation notes (BANs) issued by VIPFA, which also carry a USVI GO pledge. Another $1.3 billion is backed by matching funds from federal excise taxes levied on USVI-distilled rum. In 2013, debt service for GRT bonds and matching fund bonds totaled about $157 million, equal to 17.5% of general fund taxes and gross matching fund receipts combined. Amortization is slow, with about 34% maturing in 10 years.

Persistent underfunding has led to a large pension liability, with a funding ratio of 45.3% as of Sept. 30. 2012; the $1.6 billion unfunded liability (UAAL) equates to about 62% of estimated 2012 personal income. Other liabilities include negotiated but unpaid salary increases over the last two decades, the burden of which was estimated at $195 million as of Sept. 30, 2012. The USVI's liability for other post-employment benefits totals $1.12 billion as of Sept. 30, 2011.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. State Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=833945

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Marcy Block, +1 212-908-0239

Senior Director

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

or

Secondary Analyst

Douglas Offerman, +1 212-908-0889

Senior Director

or

Committee Chairperson

Laura Porter, +1 212-908-0575

Managing Director

or

Media Relations, New York

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com


Source: Fitch Ratings


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