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Bermuda sovereign credit ratings affirmed; outlook remains negative
Published on April 3, 2014 Email To Friend    Print Version

NEW YORK, USA -- On Tuesday, Standard & Poor's Ratings Services affirmed its 'AA-/A-1+' long- and short-term foreign and local currency sovereign ratings on Bermuda. The outlook remains negative. At the same time, Standard & Poor's affirmed its 'AAA' transfer and convertibility assessment.

Standard & Poor's issued the following statement on Tuesday:

Rationale

The ratings on Bermuda are supported by our view of the country's ongoing achievements in attracting and retaining foreign financial services companies (largely reinsurance), which underpin high per capita income; its large net external asset position; and the government's net fiscal asset position, although the latter has declined with growing deficits. Constraining the ratings are Bermuda's lack of monetary flexibility and continued gaps in official data, despite some progress.

We estimate that nominal GDP in 2014, although still much higher than that of most sovereigns at nearly US$80,000 per capita, will be 15% below its 2008 peak. Nevertheless, we expect Bermuda's economy to stabilize and begin to modestly grow in 2014-2015, particularly if its major trade and finance partner, the U.S., continues to increase its GDP by 2%-3%, in real terms, as we expect. In addition, the new One Bermuda Alliance governing party is undertaking a variety of measures aimed at economic revitalization.

Reflecting the weak economy, fiscal revenue has also declined in nominal terms, and Bermuda's deficit has gradually risen. We expect general government debt to rise by less than 2% of GDP over the next three years, after increasing by nearly 13% of GDP in 2013 (partly to prefund its financing needs in 2014-2015). We expect the government to remain in a net asset position, with large government-run defined-benefit pension fund assets exceeding gross government debt.

Still, we estimate that net general government assets will be 6% of GDP this year, down from 25% of GDP in 2006. Because banks on the island have relatively low corporate and securitization exposures, significant liquidity, and appear well-capitalized, we believe the sector still poses only a modest potential contingent liability to the government.

The Bermuda Monetary Authority operates a currency board -- as such it cannot function as a lender of last resort. The banking system has suffered over the last five years from rising nonperforming loans and 20%-30% declines in residential housing prices. The two largest banks are HSBC Bank Bermuda Ltd and Bank of N.T. Butterfield & Son Ltd. We place Bermuda's banking sector in group '4' on our Banking Industry Country Risk Assessment scale, which is from '1' to '10' ('1' being the best). Bermuda's banks collectively and individually hold regulatory capital positions well in excess of fully phased-in Basel III requirements to include the more recently introduced leverage ratio.

In our view, Bermuda's external flexibility balances high gross external financing needs against an extremely strong net external creditor position, even excluding external assets of the nonfinancial private sector. Although the recently initiated official reporting of Bermuda's international investment position represents a significant step forward in terms of statistical coverage, the lack of an estimate of households' foreign assets and liabilities still represents a significant data gap.

Outlook

The negative rating outlook reflects Standard & Poor's view of the potential for a downgrade (most likely to 'A+/A-1') over the next two years if the island's economy fails to show signs of emerging from its contraction since 2009, if the new government's fiscal consolidation plans prove difficult to implement, or if ongoing bank loan deterioration leads to further weakness in the broader banking system.

A downgrade of HSBC Bermuda, which is currently on CreditWatch with negative implications, would not likely in itself result in a downgrade of the sovereign. In 2013, total equity of HSBC Bermuda fell to $1.1 billion from $1.6 billion, largely reflecting payment of an extraordinary dividend. However, according to the Bermuda Monetary Authority, the amounts transferred by the dividend do not impact HSBC's ability to comply with Bermuda's adoption of Basel III capital standards.

On the other hand, improved prospects for GDP growth, low fiscal deficits, and a stabilization of banking-system asset quality could lead us to revise the outlook to stable.
 
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