September 19, 2017 9:57 pm Last modified: 4:47 am

Analysts Worry USVI Following Puerto Rico’s Path

The fiscal collapse of the V.I. government and some sort of Puerto Rico-style restructuring of U.S. Virgin Islands’ debt may already be all but inevitable – and the V.I. Legislature’s unwillingness to raise taxes may bring it on sooner rather than later – some financial industry analysts are starting to suggest.

"A restructuring is very possible," according to Greg Clark, Debtwire’s head of municipal research, who spoke to the Source recently by phone.

Puerto Rico defaulted on some bond payments in 2016 and Congress passed legislation creating an oversight board to restructure its debt. Congress would have to pass new legislation to do the same with the U.S. Virgin Islands.

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In December, Debtwire, a major, subscription-based financial news service for investors, raised questions about the U.S. Virgin Islands being able to sell bonds next year due to concerns that the territory will also eventually have to "restructure" its debt at the expense of investors. And, after delaying the bond sale last year, the government tried, and failed, to sell bonds to finance its current year deficit of $110 million, with a $247 million bond issue on Jan.  11.

The government decided to stop the transaction after finding that there were orders for only $127 million in senior lien bonds and $13 million in subordinate lien bonds, Gov. Kenneth Mapp said at a press conference Dec. 14.

"During 2017, if they run out of cash, if they can’t sell these bonds, if they don’t have a good five-year plan, I think you could see some additional interest from the federal government," Clark said during the recent phone interview.

Along with this year’s $110 million deficit, the USVI is facing ongoing structural deficits of around $170 million per year out of a locally funded budget of around $850 million. It has outstanding debt of more than $2 billion, not counting the debts of the government-owned V.I. Water and Power Authority, which is also facing serious financial problems. It is also facing a $3 billion unfunded pension liability and a pension plan projected to cease being able to pay full pensions by 2023.

"Most states don’t run that magnitude of debts over a period of time," Clark said. "If they do have a deficit, most states operate at maybe 5-10 percent of revenues and it’s only going to happen for a year or two," he said, adding that the only U.S. case that appears similar to the USVI is Puerto Rico.

The three major bond ratings agencies all downgraded USVI debt in 2016, citing the high level of structural debt and the lack of a credible five-year plan to address it. The Fitch ratings agency also pointed to federal intervention in Puerto Rico and the possibility of similar action in the USVI.

Last fall, the Mapp administration introduced a draft five-year deficit reduction plan to the Legislature, with tax increases, austerity measures and hopes for a large increase in revenue from the territory’s tax incentive programs. In December, the administration called the Senate into session to consider tax increases on alcohol, tobacco and time-share rentals estimated to generate $50 million per year.

The senators voted down the tax increases, saying it wanted to hear from affected businesses first.

In his Dec. 14 press conference, Mapp emphasized that lenders needed a plan for the territory to resolve its structural deficit, and that plan would require tax increases like those he proposed in December. Mapp also spoke of changes to property tax rebates that would generate more revenue.

“The rejection of new and immediate revenues into the territory … would be a decision equal to saying that we will be cutting 11 to 14 percent of the budget in order for the government to be sustained,” Mapp said.

“That $110 million removal from the current budget, well, I am not prepared to stand before the community and say this is exactly what that means. But I cannot believe that there is any person in this territory that believes that the removal of $110 million from the operating budget of the government would be an action that is painless," he said.

Debtwire’s analysts agree that tax increases to increase V.I. government revenue are the most likely path to getting anyone to buy V.I. bonds.

"I think it is difficult to sell without enactment of the tax increases and therefore without a solid five-year plan," Clark said.

But right after Mapp’s press conference, senators in the Democratic Party majority issued a statement casting doubt on the likelihood of passing tax increases and instead wishing that spending on delayed capital projects, funded by past borrowing, could fill the gap.

In that statement, Sen. Sammuel Sanes said increased taxation is not what this territory needs.

"To increase taxes on the backs of the people of this territory will not improve the financial wellbeing of our economy. Additionally, it is essential that input is included from the private sector due to the fact that the economic plight we are facing affects everyone in the Virgin Islands,” Sanes said.

"There are several projects that have been funded by the Legislature that can and will stimulate economic development,” he added. “Let’s get these projects moving. Let’s put people to work.”

There are around $144 million in funded capital projects for the territory currently, including $90 million funded by bonds backed by future federal highway funds, which senators have repeatedly urged the administration to hurry up and start.

Spending that money would improve the economy, provide jobs and increase tax revenues, but lenders and bond ratings agencies have not suggested accelerating capital spending will spur them to buy V.I. debt or improve its credit rating.

These same agencies have pointed to a desire for a credible five-year plan. And assuming all the projects are somehow begun and completed, spending all the money in the next few months, there is nothing to suggest that spending could generate the needed $110 million in new tax revenue before the end of the fiscal year in September.

Nor would the one-time acceleration in capital spending help with the ongoing structural deficit in the years following the work’s completion.

To reassure lenders and ratings agencies, the USVI recently enacted a statutory lien so lenders may get federal alcohol tax revenues before the USVI does, and also have a lien on gross receipts tax revenues.

The federal government did not move into Puerto Rico until after that territory defaulted on some bond payments. Asked if that made a USVI default and federal government intervention less likely, Clark suggested it may make little difference.

"This time they might move faster because they saw what happened in Puerto Rico," and if there is a "perceived inability to provide basic government services," Clark said. "It is not a bond default but it is a bad situation," he said.

In December, Andre Wright of Standard International Group, a financial advisor to the Public Finance Authority, told senators the government had about $730 million in remaining debt capacity for direct, general obligation debt.

Wright said the territory also had another $700 million in capacity for debt financed by federal alcohol excise taxes remitted to the territory.

Asked if those figures were accurate, Clark said those types of calculations are something of an art and "always going to be a matter of opinion." Sometimes the calculation is made based upon a statutory formula. "But there is legal debt capacity and then there is economic debt capacity (and) it is possible the market right now is telling the Virgin Islands it has exceeded its economic debt capacity," Clark said.

"You can calculate your own debt capacity, so to speak. But if someone is not willing to lend you the money you think you should be loaned, then I think the implicit conclusion is they are calculating your debt capacity differently than you did," he said.

Without the bond revenues, the government has been relying on a $60 million rolling line of credit, secured by V.I. gross receipts taxes, which the PFA renewed in 2016. The loan, which the Legislature authorized during the previous administration as a means to smooth out cash-flow issues, comes due at the end of September 2019.

In November 2016, the USVI drew down $20 million on the line of credit, administration officials said during Senate hearings in December. The government planned to draw down another $20 million by the end of the first quarter of calendar year 2017 – or around the end of March.

But, according to Debtwire’s analysts, that will only happen after the government issues the bonds and if the Fitch rating agency affirms its “BB” ratings on both the bonds secured by gross receipts taxes and those secured by federal alcohol excise tax matching funds. And the bonds are not selling, limiting the government’s options.

"During 2017, if they run out of cash, if they can’t sell these bonds, if they don’t have a good five-year plan, I think you could see some additional interest from the federal government," Clark said.

If taxes are increased, the territory might be able to borrow but that won’t solve the territory’s problems, Clark said.

"If they passed those levels of increases … and assuming those taxes didn’t depress economic activity, they might still have some problems," Clark said.

Taxes are only a part of the five-year plan. An even more important component is the hoped-for large increase in revenue from the EDA tax break program. While administration officials assert the EDA expansion goals are realistic, the trend in recent years has been in the opposite direction.

The tax break program brings significant revenues to the V.I. government. In the 11 years from 1999 through 2009, tax program beneficiaries had gross sales amounting to $14.9 billion and paid $1 billion in local taxes – roughly $91 million per year on average.

Every year for the past decade, during both the administration of former Gov. John deJongh Jr. and the current Mapp administration, EDA officials have said during budget hearings they are working hard to sell the tax break program, streamline the application process and bring in more beneficiaries. Yet, despite being a priority for both administrations, in 2011 there were 98 companies in the EDA’s tax break program and a year later, in 2012, there were 84.

As of Aug. 17, 2016, the last time it was updated, the EDA website listed 66 tax benefit recipients, including about 15 that are long-time V.I. companies such as hotels, paving companies and shopping malls. A large increase in EDC revenue will require a sharp reversal of that long-term trend.

If the Senate changes its mind and tax increases are put in place and the EDC increases go as planned, there are still deadly icebergs looming not far off.

When he presented the Mapp administration’s five-year plan to senators in September, Finance Commissioner and PFA Director Valdamier Collens said if all the measures were carried out, the territory could balance its budget by 2021. But in December, Collens said during Senate hearings on proposed tax increases that they recalculated their projections to remove revenues that could come from a restart of the Hovensa refinery and other funds. Now the administration projects a smaller, roughly $56 million deficit in 2021, even if the new taxes and the rest of the five-year plan are all enacted and successful.

Behind all of it lurks the pending explosion of the government pension system. The V.I. Government Employee Retirement System is projected to exhaust all by assets in 2023, at which point the government’s General Fund would be on the hook for about 55 percent of the GERS’s $200 million-plus annual pension payments – more than $100 million per year added to the budget deficit. (See: GERS Collapse Will Come, Retirees Better Start Planning in Related Links below)

Mapp said in his 2016 state of the territory address he intended to introduce a comprehensive plan to address the looming GERS crisis. As of Jan. 16, 2017, no plan has been introduced and it is not clear there is any viable solution short of the unlikely, generous intervention of the federal government. At this point, extremely drastic increases in employee contributions would be necessary to slow the impending insolvency.

Once the pension plan exhausts its assets, it will be able to pay about 45 percent of current benefits and the V.I. government will be on the hook for the rest. If it does not pay, pensioners will have much less money to spend on food, groceries, rent and utilities, reducing economic activity and tax revenues further.

For all these reasons, Debtwire analysts think a debt structuring "seems very possible," Clark said.

"The way to avoid one would be either a big increase in revenues or a big decrease in expenditures, or both, to begin paying down the debt," Clark said. So far, neither option appears imminent.

Collens and PFA financial advisor Andre Wright did not respond to requests for comment.

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