DBRS Confirms Province of Newfoundland and Labrador at “A” and R-1 (low)

DBRS has today confirmed the short- and long-term debt ratings of the Province of Newfoundland and Labrador (Newfoundland or the Province) at R-1 (low) and “A”, respectively. The trend on both ratings is Stable. The Province’s fiscal position deteriorated in the wake of the recession as demand and prices for many of the commodities that generate a significant proportion of provincial revenue declined. A conscious decision was made by the Province to protect social programs and to provide stimulus by way of aggressive capital spending in an effort to minimize the impact of the recession on the economy. While the economy remains vulnerable to the volatility of resource industries, the fiscal situation is now improving as the global economy recovers.

The Province remained in a deficit position at the end of the 2009-10 fiscal year, with a reported shortfall of $295 million. This equates to a deficit of $489 million in DBRS-adjusted terms after recognizing capital expenditures as incurred, rather than as amortized. This constitutes a significant improvement, however, from the $750 million deficit that had originally been budgeted by the Province, or $1.1 billion in DBRS-adjusted terms, and in spite of a precipitous 21% drop in nominal GDP. Royalties from offshore oil resources came in at more than half a billion dollars higher than expected and were solely responsible for the improved performance.

For 2010-11, the Province is forecasting a deficit of $194 million. In DBRS-adjusted terms, a $699 million deficit is expected, representing 2.5% of GDP. This compares with an average of 2.8% for all provinces. Total revenues are expected to climb by 5.1% as personal income tax and sales tax receipts increase on the back of real GDP growth that is anticipated to register at 4%.

On the expenditure side, Newfoundland faces the same challenge as all other provinces, with health-care spending projected to increase by $182 million in 2010-11, contributing to a total increase in spending of 3.5%. Gross capital expenditure is planned to increase to $1.2 billion, up from $707 million in 2009-10. While high by historical standards, this level of capital expenditure reflects the significant stimulus measures introduced by the Province in an attempt to moderate the economic impact of the recession.

The Province recently indicated that it remains on track with its budget, notwithstanding the impact of Hurricane Igor. The hurricane wrought much damage across parts of the island in September 2010, causing flooding and washing away roads and bridges. Preliminary estimates peg clean-up and reconstruction costs at approximately $100 million. Federal disaster relief assistance is expected to compensate the Province for up to 90% of costs incurred. However, it may take a number of years for funds to flow to the Province under the applicable federal programs.

Development of the hydroelectric power-generating potential of the lower Churchill River remains a priority for the Province. While DBRS views development of the lower Churchill as a net positive over the long term, the project’s substantial financing requirements, estimated to be between $6 billion and $9 billion, may place the Province’s rating under stress in the short to medium term, depending on the financing structure used and the level of recourse to the Province.

The Province made significant headway in reducing its debt-to-GDP ratio from a peak of over 80% in the 1990s to a low of 28.6% in 2008-2009. The trend was reversed in 2009-10, as this measure of financial flexibility climbed to 36.0% due to an increase in pension liabilities and a drastic drop in nominal GDP. Renewed GDP growth fuelled by a number of large capital projects combined with no net new borrowing in 2010-11 should allow the debt-to-GDP ratio to resume its downward path to a projected level of 32.7%.

Despite an improving economic outlook with real growth of 4.0% and 3.1% projected in 2010 and 2011, respectively, the Province continues to budget for moderate deficits in those years; this stands in contrast to the expected return to balance in 2011-12 projected in last year’s budget. While current financial metrics remain supportive of the rating, DBRS notes that continued deficit financing will significantly slow improvement in the Province’s credit profile in the medium term. DBRS expects Newfoundland to continue to exercise the fiscal discipline displayed in recent years and to take the measures necessary to return to a balanced fiscal position.

Note:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Canadian Provincial Governments, which can be found on our website under Methodologies.