DBRS Confirms Newfoundland and Labrador at “A” and R-1 (low), Stable Trend

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 is slightly improved since the last rating update. However, weakening federal transfers, as the Province will no longer accrue revenue associated with the Atlantic Accord, and lower-than-budgeted oil prices could pressure fiscal flexibility in the short term. Development of the lower Churchill River hydroelectric project in Labrador presents more of a balanced risk to the Province’s credit profile as it could increase debt levels, materially so in the case of cost overruns, but also presents opportunities over the longer term.

For the fiscal year ending March 31, 2012, the Province recorded a surplus of $776 million based on preliminary results, or a $361 million surplus on a DBRS-adjusted basis after recognizing capital expenditures as incurred rather than as amortized; this represents a substantial improvement over the $459 million DBRS-adjusted deficit that had been expected. The better-than-expected fiscal performance was the result of both oil prices and production levels being higher than projected.

A DBRS-adjusted deficit of $691 million, or 2.0% of GDP, is forecast for the current fiscal year as federal transfers related to the Atlantic Accord have come to an end and oil production is expected to be down year-over-year. DBRS notes that the price of Brent crude has been significantly below the budget assumption of US$124.12/barrel for much of the current year. Unless oil prices recover sharply, this represents a significant downside risk to fiscal projections. DBRS estimates that the DBRS-adjusted deficit could climb to over $1 billion under current oil prices.

The Province is projecting another year in the red for 2013-14, with an as-reported deficit of $433 million expected (approximately $850 million DBRS-adjusted, given historical capital expenditure), as resource revenues continue to decline on falling production levels at mature offshore fields. The expected deficits are manageable, in light of the Province’s credit profile. Anticipated growth in non-resource revenue has allowed for a small as-reported surplus of $44 million (or an approximately $400 million DBRS-adjusted deficit) to be planned for 2014-15. In order to meet this target, spending restraint will be necessary as program expenditure growth averaging more than 8% over the last five years is incompatible with declining revenue. However, as with all of the Province’s fiscal forecasts, volatility in oil prices and production levels lend a degree of uncertainty to anticipated results.

Newfoundland continues to post robust economic indicators. Real GDP growth in 2011 is estimated by the Province at 4.3%, although preliminary information from Statistics Canada suggests growth may have been slower at 2.8%. Employment was up by 2.7%, which pushed unemployment down to 12.7%, a 36-year low. Average weekly wages in Newfoundland were the third highest in the country in 2011, and above the national average for the first time. Major capital projects related to resource development drove economic results. Real GDP in 2012 is expected by the Province to increase by only 0.1% due to falling production levels at offshore oil fields. The average of private sector forecasts tracked by DBRS predicts 1.8% real growth. In the absence of a rebound, oil prices that have tracked below the budget assumption of US$124.12 may dampen nominal GDP numbers.

The Province’s debt-to-GDP ratio stood at 27.2% as of March 31, 2012, down from 32.0% the previous year and at the low end of the spectrum for the rating category. DBRS estimates that debt-to-GDP will stand at 27.0% on March 31, 2013. The Province does not intend to issue debt in the current year as cash on hand is sufficient to fund the expected deficit and would remain so even in the event of a large fiscal deterioration caused by low oil prices. However, as has been the case for a number of years, rising unfunded pension liabilities will offset maturing debt, keeping total debt stable. Uncertainty remains with regard to the Province’s plan to develop the hydro potential of the lower Churchill River. Depending on the financing structure used and the level of recourse to provincial taxpayers, the rating could be materially affected, especially in the case of significant cost overruns. The Province has indicated that a final decision on the project will be made before the end of 2012.

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.