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

DBRS has today confirmed the long- and short-term debt ratings of the Province of Newfoundland and Labrador (Newfoundland or the Province) at “A” and R-1 (low), respectively. The trend on both ratings is Stable. The Province’s fiscal position has improved somewhat since the last DBRS rating update. However, weakening revenues, especially from federal transfers, will create challenges in the near term. Development of the lower Churchill River hydroelectric project in Labrador could also increase debt levels, depending on the financing structure adopted, but the project does present opportunities over the longer term.

For the fiscal year ending March 31, 2011, the Province recorded a surplus of $485 million based on preliminary results, or a $2 million surplus on a DBRS-adjusted basis after recognizing capital expenditures as incurred, rather than as amortized; this represents a substantial improvement over the $699 million DRBS-adjusted deficit that had been expected. Unlike some previous years in which better-than-expected fiscal performance was attributable exclusively to royalties from offshore oil coming in higher than projected, the improved performance was more broadly based, with increased taxation revenues also contributing to year-end results. The recent trend of sizable expenditure growth continued in 2010-11, with spending up 6.5%, driven by health, education and capital expenditure. The Province maintained a sizable capital program and increased program spending, despite already robust private sector capital investment and strong economic indicators.

A DBRS-adjusted deficit of $459 million is forecast for the current fiscal year as revenue is expected to decline across almost all sources while expenditures continue to climb at a pace of 4.0%. The Province is budgeting for as-reported deficits of $496 million in 2012-13 and $310 million in 2013-14. Declining revenues, specifically lower oil royalties (caused by lower production levels) and federal transfers associated with the Atlantic Accord, are largely to blame for the expected negative results. The Province expects to return to balance in 2014-15 on the strength of own-source revenue growth.

In economic terms, the Province continues to post growth numbers that rank first in the country on many indicators. Real GDP growth for 2010 is estimated at 5.6%, with a forecast of 3.0% growth in 2011. Solid growth in personal income and disposable income has powered retail sales. Construction activity, driven by large projects, government infrastructure spending and housing starts at a 30-year high remained robust. Employment grew by 3.3% in 2010 and the Province has now more than recouped all jobs lost during the recession.

For 2012, the Province is forecasting moderate real growth of 0.2%, or 1.4% in nominal GDP. The Province expects growth in real GDP to average 1.1%, or 3.4% nominal, over the five years to 2015. The main drivers are expected to be consumption and investment related to large capital projects. These numbers are somewhat volatile and are heavily influenced by the timing of expenditures on large projects and the vagaries of oil production and prices. The lower Churchill project, while potentially presenting challenges in the near term, will have an immediate economic impact when work ramps up in 2012; the project has the potential to have a lasting influence on the Province’s economy by providing a substantial and sustainable source of export revenue.

Provincial DBRS-adjusted debt has remained stable at around $9.0 billion for a number of years. Newfoundland has not issued new net debt since 2007 and has no plans to issue in the immediate future. Despite the paying down of market debt, the debt burden has remained essentially constant as unfunded pension liabilities continue to grow, standing at an estimated $2.7 billion as of March 31, 2011. With the debt level remaining steady, the debt-to-GDP ratio has become almost exclusively a function of nominal GDP growth. The ratio spiked to 35.9% in 2009-10 as declining oil prices pushed nominal GDP down by more than 21%. With robust nominal growth of 18.8% estimated for 2010, the indicator has fallen to 30.5%.

While Newfoundland’s current debt and fiscal profile are appropriate for the rating, the lower Churchill project introduces an element of uncertainty into the outlook. The Province is responsible for financing $4.4 billion of the $6.2 billion project. It is not clear how the Province intends to fund its portion and there are numerous financing options and scenarios that could be employed, including a guarantee from the federal government. However, if the Provinces elects to fund a large portion of the cost with taxpayer-supported debt, the current rating could come under pressure.

A provincial election is scheduled for October of this year. This will be the first opportunity the electorate has had to go to the polls since the resignation of the popular former premier Danny Williams in December 2010. Recent polls indicate that the governing Progressive Conservative party has maintained a substantial lead in popularity under the leadership of Premier Kathy Dunderdale.

Notes:
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.