DBRS Morningstar Changes Trend on the Province of Newfoundland and Labrador to Stable from Negative, Confirms Ratings at A (low)

DBRS Limited (DBRS Morningstar) changed the trends on the Province of Newfoundland and Labrador’s (Newfoundland or the Province) Issuer Rating and Long-Term Debt rating to Stable from Negative and changed the trend on the Guaranteed Long-Term Debt of Newfoundland and Labrador Hydro to Stable from Negative. DBRS Morningstar also confirmed the Province’s Issuer Rating and Long-Term Debt rating at A (low) and confirmed its Short-Term Debt at R-1 (low). Concurrently, DBRS Morningstar confirmed Newfoundland and Labrador Hydro’s Guaranteed Long-Term Debt and Guaranteed Short-Term Debt at A (low) and R-1 (low), respectively. The trends on all short-term ratings remain Stable.

At the time of DBRS Morningstar's December 2020 rating report on the Province, DBRS Morningstar indicated that it could change the trends on the long-term ratings to Stable with increased clarity that adjusted deficits will begin to trend below 5.0% of GDP and that debt will stabilize below 80% of GDP, or with increased clarity around how costs related to Muskrat Falls will be recovered and the extent to which provincial subsidies will be necessary for electricity-rate relief. Given the improving economic and fiscal environment, DBRS Morningstar has increased confidence that adjusted deficits will trend well below 5.0% of GDP and adjusted debt-to-GDP will stabilize well below 80%. Furthermore, the agreement in principle (AIP) announced with the Government of Canada (Canada; rated AAA with a Stable trend by DBRS Morningstar) on the financial restructuring of the Lower Churchill Projects (Muskrat Falls Generating Project) will allow the Province to achieve its electricity-rate mitigation targets while ensuring that project costs continue to be covered through the electricity-rate base.

The Province released its 2021 budget on May 31, 2021. This is Newfoundland's first budget following a drawn-out election that saw the Liberal Party win a majority government in March 2021 in the Province's first mail-in-only election. For 2021–22, the Province is forecasting a deficit of $825 million, a marked improvement from the $1.6 billion shortfall estimated for 2020–21. On a DBRS Morningstar-adjusted basis, this equates to a shortfall of $924 million, or 2.5% of GDP after making adjustments to recognize capital spending as incurred.

Over the medium term, Newfoundland's deficit is projected to fall sharply and steadily, supported by a recovery in provincial own-source revenues, including higher commodity prices, and increased federal transfers while program spending will be held relatively flat over the medium term. Newfoundland projects a deficit of $587 million in 2022–23, before falling to just $88 million in 2025–26. On a DBRS Morningstar-adjusted basis assuming stable capital expenditures, these equate to deficits of 1.6% to just 0.2% of GDP. While this outlook is favourable in relation to some other provinces, it is subject to ongoing implementation risk.

Subsequent to the budget, on July 28, 2021, Newfoundland announced an AIP with Canada on the financial restructuring of the Muskrat Falls Generating Project. The agreement entails $5.2 billion in various forms of financial support, which will be used to mitigate the impact of project costs on electricity rates to achieve a target rate of 14.7 cents per kilowatt hour. As a result, existing provisions built into the budget for electricity-rate mitigation are now no longer likely to be needed, resulting in potential improvement in Newfoundland's budgetary outlook as result of this agreement. In addition, Newfoundland and Canada also announced an agreement to implement the Early Learning and Child Care Action Plan, although DBRS Morningstar anticipates that this agreement will be fiscally neutral. While both of these agreements are subject to the outcome of the September 20, 2021, federal election, the federal Conservative Party has indicated its support for the former agreement.

Based on an improving fiscal outlook and a strong rebound in nominal GDP, DBRS Morningstar estimates that the adjusted debt-to-GDP ratio will fall to 60.4% in 2021–22. However, the trajectory for debt-to-GDP over the medium term remains subject to uncertainty and will be dependent on the pace and magnitude of the economic recovery and the Province’s ability to gradually reduce the deficit. Based on the Province's medium-term fiscal outlook and debt projections provided to DBRS Morningstar, adjusted debt-to-GDP is expected to increase gradually, approaching approximately 67% in 2025–26. Furthermore, following the conclusion of final agreements on the Muskrat Falls restructuring and confidence that the majority of costs of the project will be recovered primarily through the rate base and federal supports, DBRS Morningstar would expect to reduce or remove the negative overlay on the credit ratings. This would be credit positive, but insufficient on its own to lead to a further positive rating action.

For 2021, the Province anticipates real GDP growth of 5.6%, followed by 2.6% in 2022. This compares with the current private-sector consensus forecast pointing to real GDP growth of 4.2% and 2.3% in 2021 and 2022, respectively. Current forecasts for economic recovery are largely contingent upon the pace of global economic recovery and associated impacts on commodity prices, production, and major project investment, along with the Province's ability to manage the ongoing Coronavirus Disease (COVID-19) pandemic and vaccine rollout—much of which is subject to a reasonably high degree of uncertainty.

RATING DRIVERS
A negative rating action now appears less likely but could arise from material underperformance of current expectations that leads to adjusted deficits trending above 5.0% of GDP and debt-to-GDP above 80%. Conversely, while unlikely in the near term, a positive rating action would be dependent on a combination of (1) conclusion of the Muskrat Falls AIP and confidence that project costs will be primarily recouped through the rate base and federal supports; (2) continued fiscal improvement beyond current expectations; and/or (3) debt-to-GDP returning to pre-pandemic levels.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Canadian Provincial and Territorial Governments (May 3, 2021; https://www.dbrsmorningstar.com/research/377881) and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (May 31, 2021; https://www.dbrsmorningstar.com/research/379424), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (https://www.dbrsmorningstar.com/research/373262; February 3, 2021).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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 under Related Documents or by contacting us at [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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