DBRS Downgrades Province of Newfoundland and Labrador to A (low), Changes Trend to Stable

DBRS Limited (DBRS) has today downgraded the Issuer Rating and Long-Term Debt rating of the Province of Newfoundland and Labrador (Newfoundland or the Province) to A (low) and changed the trend on the ratings to Stable. DBRS has also confirmed the Province’s Short-Term Debt rating at R-1(low) with a Stable trend. At the same time, DBRS has downgraded the Guaranteed Long-Term Debt ratings of Newfoundland and Labrador Municipal Financing Corporation and Newfoundland and Labrador Hydro to A (low) and revised the trends to Stable. Additionally, DBRS has confirmed the Guaranteed Short-Term Debt rating for Newfoundland and Labrador Hydro at R-1 (low) with a Stable trend.

On January 21, 2016, DBRS placed the Province’s long-term ratings on a Negative trend based on the expectation that the rapid decline in oil prices would contribute to a material erosion in fiscal performance and significant accumulation of debt. While oil prices have recovered somewhat since that time, Newfoundland’s 2016–17 budget, released on April 14, 2016, confirms that fiscal erosion is significant. The budget is based on a Brent oil price assumption of USD 40/barrel (bbl) in 2016–17 rising to USD 52/bbl in 2017–18 and USD 60/bbl in 2018–19. This points to a material deterioration in the economic and fiscal outlook that is expected to push debt significantly higher. On a DBRS-adjusted basis, debt is estimated to have reached about 43% of GDP in 2015–16 and could potentially exceed 60% of GDP as early as 2018–19, a level not seen since 2003 and considered more consistent with an A (low) rating given the Province’s economic fundamentals.

The extent of the budget imbalance is considerable. For 2015–16, the budget deficit is estimated at $2.2 billion. On a DBRS-adjusted basis, after including capital expenditures as incurred, this equates to a shortfall of $2.3 billion, or 7.6% of provincial GDP, compared with 7.0% of GDP anticipated when the trend was changed in January.

While the government’s plan sets a timeline to return to balance in six years, with specific deficit targets, the measures announced thus far are limited to those that can be readily implemented by a new government. They include broad-based increases in taxes and fees and some reductions in program spending. However, the more substantive proposals for restructuring programs and reducing spending are still being developed and will not be presented until the fall. For 2016–17, budget estimates point to another large DBRS-adjusted deficit of approximately $1.9 billion, or 6.4% of GDP, with deficits falling to approximately 3.0% of GDP in 2017–18 and gradually declining thereafter. There is downside risk to the revenue forecast should oil prices remain lower for longer or should the economy underperform expectations.

A further challenge to achieving the return to balance remains the weak economy, which may hinder the government’s ability to generate targeted revenues and inhibit the government’s willingness to make necessary structural reforms. The economy has already been heavily affected by the oil price correction, and as the major investment projects near completion (e.g., Hebron and Muskrat Falls), the economic outlook is only expected to deteriorate further. The Province expects a prolonged period of adjustment characterized by years of economic contraction, declines in population and employment, and for unemployment to rise to nearly 20%. Further revenue increases or reductions in capital or program spending would likely worsen economic performance.

Notwithstanding these challenges, the trends on the ratings have been revised to Stable because, in DBRS’s view, the government is committed to taking credible action as reflected by the substantive and difficult decisions announced in the current budget, with more measures forthcoming in the fall. However, risks remain tilted to the downside, as the outlook for the economy remains weak and the plan to reach balance is incomplete. DBRS will continue to monitor the Province’s efforts to restore fiscal sustainability.

The projections in this press release reflect a preliminary analysis of the fiscal plan. DBRS will complete a formal in-depth review of the Province and will provide a full report on the credit in the coming months.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Canadian Provincial Governments and DBRS Criteria: Guarantees and Other Forms of Explicit Support, which can be found on our website under Methodologies.