OUTLOOK BLEAK FOR VIRGIN ISLANDS BOND BEARERS; BANKRUPTCY IS NOT AN OPTION
CHARLOTTE AMALIE – The outlook is bleak for Virgin Islands bond bearers and bankruptcy is not an option for the government agency Gov. Kenneth Mapp used to manage before becoming governor, according to the Fitch Ratings by Berkshire Hathaway.
The Fitch Ratings determined that there is $765.8 million in outstanding USVI Public Finance Authority (VIPFA) bonds,Virgin Islands gross receipts tax (GRT) loan note (senior lien) at ‘BBB’ coupled with the implied general obligation (GO) bond rating for the territory at “BB-minus“ (there are no outstanding USVI stand-alone GO bonds) so its “rating outlook remains negative,” the Fitch Ratings said in a report released this month.
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 Virgin Islands government. KEY RATING DRIVERS GRT SECURITY INSULATED FROM GOVERNMENT OPERATIONS: Bonds issued by the VIPFA and secured by the GRT are insulated from general fund operations through a collection process that allocates pledged revenues to a separate escrow account. Debt service coverage remains satisfactory; MADS coverage from fiscal 2014 GRT revenue was 2.6x for senior lien debt and 2.5x for all GRT-secured obligations, and revenues have stabilized as the strengthening US economy has increased tourism in the USVI. The Negative Outlook reflects concern that the USVI will over-leverage this revenue source in light of its limited economy and strained financial operations NARROW AND WEAK ECONOMY: The economy is limited, dependent on tourism and vulnerable to disruption from natural disasters. The closure in 2012 of the Hovensa refinery, the USVI’s former largest taxpayer and employer, resulted in sizable employment and government operating revenue losses.
WEAK FINANCIAL POSITION: Longstanding fiscal challenges were compounded in the most recent recession and by the closure of Hovensa. A volatile trend in revenues has strained financial operations and the USVI continues to grapple with high fixed-cost burdens and difficulty in reducing expenditures. Enacted budgets are routinely imbalanced and the territory has relied on borrowing to close both its operating gaps and maintain liquidity; practices that are expected to continue into fiscal 2016. Fitch believes future budgeting options are limited, resulting in the maintenance of the Negative Outlook.
MARKET ACCESS FOR BORROWING IS ESSENTIAL: Given the USVI’s need to borrow for liquidity purposes, an inability to access capital markets for this purpose would pressure the rating. 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. 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 stability through some oversight of financial operations as well as the allocation of grant and operating revenue.
RATING SENSITIVITIES For the GRT bonds: The rating is sensitive to a reduction in GRT revenues, leveraging that notably reduces debt service coverage ratios, and weakening in the USVI’s general credit characteristics. For the Implied GO Rating: The rating is sensitive to further erosion in the USVI’s financial position and/or deterioration in the USVI’s economy, continued issuance of debt 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 USVI’s implied GO rating of ‘BB-‘. The implied GO rating of ‘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. Budget imbalance is expected to remain over the next several fiscal years and the USVI is considering a refinancing of its outstanding GRT and matching fund bond debt service to provide budgetary relief over the next five fiscal years. While the exact structure of the refinancing is currently unknown, the USVI is targeting $280 million in aggregate budgetary savings through fiscal 2020 or about $56 million per annum over the next five fiscal years. Fitch will review the refinancing and the USVI’s financial plans, once they are announced, to determine if there is any impact to the ratings for the implied GO and GRT bonds. The economy is limited and unemployment rates remain high following the large layoffs related to the closure of HOVENSA 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, to balance the budget in the fiscal year ending Sept. 30, 2012 and close a gap caused in part by expected revenue losses related to the January 2012 closure of Hovensa, the USVI’s former largest employer and taxpayer. The increase in rate initially contributed to 5.5% revenue growth in fiscal 2012; however, the softening economy led to a 0.3% decline in fiscal 2013. Revenue in fiscal 2014 showed stability with 0.6% growth to almost $157 million, providing solid coverage of debt service. Senior lien debt service coverage from fiscal 2014 collections that are certified by an independent auditor was 3.1x when including unrated, junior lien obligations, combined debt service coverage was 2.8x that year. These coverage levels are down notably from the prior fiscal year (senior lien coverage of 3.6x and combined coverage of 3.4x) due to the modest growth in GRT revenue and a significant increase in debt service requirements related to cash flow and capital bond issuance. Coverage of maximum annual debt service (MADS) on all GRT-secured debt was 2.5x by fiscal 2014 revenues, down from 2.7x by fiscal 2013 revenues. The USVI has budgeted for 5.6% growth in GRT collections for fiscal 2015, which ends on Sept. 30, 2015, and Fitch believes this target is achievable based on very strong collections through the first half of the fiscal year (up 10.5% year over year [yoy]), supported by recent solid growth in the USVI’s tourism industry. Fiscal 2015 budgeted revenues would produce annual debt service coverage on senior lien debt of 3.1x while coverage of all-GRT debt would approximate 2.7x. Coverage of MADS on all GRT debt from budgeted revenues in fiscal 2015 indicate a MADS coverage level of about 2.6x.
ADEQUATE SECURITY PROVISIONS
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 were $79 million in fiscal 2014. The USVI and VIPFA are ineligible to file for protection under the U.S. Bankruptcy Code.