Dealing with the downgrade: An action plan for Bermuda

Make text smaller Make text larger

It is said they often don’t do it fast enough, or in language firm enough, but in the drill-down the ratings agencies tell it like it is.

Last week, Fitch Ratings made it unanimous with Standard & Poor’s and Moody’s: Bermuda goes down one notch in its Long-Term Foreign Currency Issuer Default Rating, from AA+ to AA, and in its Long-Term Local Currency Issuer Default Rating from AAA to AA+.

In simple terms, what that means is the US-based rating agency feels Bermuda is the slightest bit less likely to pay back what it borrows, mostly from overseas lenders.

The reasons were clear: An economy and local industries that are not yet recovering from the downturn, Bermuda’s rising national debt and the lack of a sure plan to emerge from the slump. Add to that the island’s dependence on a barely crawling US economy, coupled with the European tailspin hurting many of Bermuda’s business partners, and there’s reason the ratings agency is sceptical.

Anyone who was surprised at the ratings cut has had their eyes closed for a long time. Ratings agencies tend to telegraph their coming moves and often get in line with each other over time. Standard & Poor’s made its call in December 2011, and Moody’s in April of 2012.

That’s their job, to research and give an opinion on the creditworthiness of a borrower. Investors act accordingly, asking for a return reflecting the level of risk they’re taking.

The fiscal implication for Bermuda is that it might have to pay higher interest to attract buyers for its bonds in an environment where lots of borrowers compete for funds. A noteworthy metric to follow is the yield at which Bermuda borrows relative to the other benchmarks called the spread can be affected by ratings actions. A careful watch of these figures will tell us what the market believes going forward.

All is not grim however the Long-Term Foreign Currency Issuer Default Rating of AA, and Long-Term Local Currency Issuer Default Rating of AA+ is a very high rating in the scheme of other sovereign debt issuers. Bemuda is in the company of small but solid economies such as Belgium and New Zealand, along with the oil patch states of Saudi Arabia, Abu Dhabi and Kuwait in the AA range.

But with the downgrade, Bermuda has been welcomed to the world’s fiscally challenged club. Virtually every nation is a higher credit risk today than it used to be. Many sovereign and financial institution issuers have been or are at risk of a downgrade. A look at the Fitch website shows it’s happening all the time.

Fitch took Japan from AA to A+ on May 22, Spain from A to BBB on June 7 and Egypt from BB- to B+ on June 15 - all with a negative outlook, meaning the next ratings change will probably be down rather than up.

Bermuda’s outlook is stable, but this is not reason to relax.

Fitch cited Bermuda’s “narrow and volatile” revenue base, “lack of economic diversification,” and an economy that “depends extensively on tourism and insurance”, which have both lost ground.

The assessment is sobering, and though Fitch said Bermuda’s wealth, savings rate, appeal to financial services companies and highly skilled workforce keep its rating from going lower at the moment, Bermuda’s leaders should take the downgrade as a call to action.

Austerity is one antidote to a challenged fiscal position. However, the best way to solve a fiscal problem is to grow the economy - not so easily done on an island in the middle of the ocean with a small population and modest natural resources. It takes a plan and decisiveness by the government to put in place the right environment for indigenous businesses to grow, and to lure new businesses because they like what they see.

Bermuda has comparative advantages in its legal system, strong regulations, taxes, US proximity and professional workforce, Fitch said, and is “a domicile of choice for insurance, reinsurance and financial services companies”. Other businesses hedge funds for example that also need the competencies Fitch highlighted should be targeted, recruited and welcomed to Bermuda.

Bermuda’s leaders would do well to assess the Island’s strengths, implement measures to enhance them where necessary, and market them to the companies and industries that could benefit by being in Bermuda.

Insurers once came in droves when they learned of Bermuda’s advantages. Other businesses, too, should be shown the reasons why Bermuda is the place to be.

Bermuda could provide a solution for them, and they, in turn, for Bermuda. And that could prompt Fitch and its peers to restore all the A’s and plus signs that will signal to the world just how good of a risk Bermuda really is.

Michael Stockman has been associated in an executive capacity for the financial services industry since 1985, for such major firms as Salomon Brothers, Goldman Sachs & Co, and UBS Investment Bank. He is currently president of MG Stockman Advisors, LLC, headquartered in New York City.

Make text smaller Make text larger

Take Our Poll