The U.S. Virgin Islands said deep downgrades to its junk-rated bonds on Tuesday and Wednesday were unfairly based on Puerto Rico’s recent history of defaults.
The islands' senior matching funds bonds were downgraded on Tuesday to B by Fitch Ratings and on Wednesday to CCC-plus by S&P Global Ratings. The gross receipts tax bonds were downgraded to B by Fitch and CCC by S&P.
The agencies have negative outlooks on these ratings.
The government has $1.85 billion in bonds outstanding, according to Fitch, not including the $216 million of debt of its Water and Power Authority, whose ratings are also deep in speculative territory. WAPA is in the midst of borrowing another $85 million, mostly for an electrical power plant.
A spokesman for the Virgin Islands responded to the downgrades Wednesday with a rhetorical question: “What is different in the USVI than it was two years ago, other than the government has aggressively and proactively made efforts to cut spending, increase revenues, initiate so called ‘sin taxes’ and other fees, cut the 2017 budget, reduce the 2018 budget by close to 10 %, initiated an agency by agency cost cutting measures, etc.?
“What is different is that Puerto Rico went bankrupt and the USVI has been tainted by these actions. The rating agencies have just failed to look at the USVI separately from developments in Puerto Rico and that is not fair or accurate,” the spokesman said in an email.
The ratings agency analysts saw things differently. Both Fitch senior director Marcy Block and S&P credit analyst Oladunni Ososami pointed to increased accounts payables as a sign of the government’s inability to sustainably handle its finances. Block said the Virgin Islands’ government expected accounts payable to increase by $62 million at the end of this fiscal year compared to the end of the last fiscal year.
The Virgin Islands fiscal year ends on Sept. 30.
Ososami said the government was “vulnerable to a total depletion of cash before the end of the current fiscal year.” She said the agency’s negative outlook was because the government’s five-year plan for its budget was “optimistic.”
Both analysts said the U.S. adoption of the Puerto Rico Oversight, Management, and Economic Stability Act in the summer of 2016 has weighed on their ratings of the Virgin Islands’ debt. They say the act opens the door for the federal government to extending bankruptcy protection to the islands’ debt. The passage of PROMESA a year ago wasn’t the immediate trigger for Tuesday’s and Wednesday’s rating action, they said.
Municipal Market Analytics partner Matt Fabian said in an email, “The rating agencies have to consider the potential for a PROMESA style restructuring of the VI that could, like it might do in PR, dissolve layers of bondholder security. Frankly, in a post-PROMESA world, territory bonds have to be considered potentially reducible to a debenture or worse, regardless of the security. That doesn’t mean they’re not lendable borrowers, but there’s a fair degree of credit, performance, and liquidity risk in the bonds that shouldn’t be bought lightly.”
“CCC category ratings are probably appropriate for a struggling government like VI,” Fabian said.
“Puerto Rico has taught [the] rating service[s] a valuable lesson,” said Shaun Burgess, portfolio manager at Cumberland Advisors. “The governor of the Virgin Islands may say they are going to pay their debt but so, too, did the governor of Puerto Rico, right before they couldn’t pay it and sought help from Congress.”
In explaining the downgrade Block also pointed to net tax-supported debt and unadjusted, unfunded pension obligations attributable to the islands at 223% of 2014 personal income, which she described as an “extremely high” burden.
Block said that the governor’s proposed fiscal year 2018 budget relies on a “strong” 7.6% growth in revenues. “Fitch believes the government has a long path to right-size its budget given the extent of the structural challenges.”
Moody’s Investors Service rates the senior and subordinated matching fund bonds Caa1 and the subordinated indenture Diageo and Cruzan bonds Caa2. It has negative outlooks on these ratings.
The Virgin Islands government said that its “economy remains on the upswing and new revenue is anticipated" in fiscal 2018.
“While I concede we have much work to do and that we are striving to do better, we are well on our way to accomplish our task of fiscal responsibility and sound fiscal balance,” said Gov. Kenneth Mapp.