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Favourable bond rate gives Bermuda a window

Most readers will be familiar with articles I have penned on Bermuda's debt in past issues of Financial Ramblings from the Rock. The recent refinancing conducted by the Bermuda Government is resurrecting this commentary. I swore to avoid a quotidian writing on the sovereign debt situation unless something material changed. Well, something has. Bermuda's government, not unlike many other nations, has been given a reprieve. A window if you like to right the ship and sail a more prudent course. A course to correct prior wrongs and prevent burdening future generations with a legacy of fiscal irresponsibility.

As previously reported, the recent ten-year issuance of $665 million was done at a very favourable rate. The 3.717 per cent issue is the lowest ever. The refinancing also extended the maturity profile of the existing Bermuda Government debt with the most of the maturities at 2023 or later.

A large tranche of $180 million with a weighted rate of 6.74 per cent is not due till 2019. The new issue coupled with refinancing of higher coupon debt will help save $5.6 million in interest annually. Why0 is this happening? There are three major structural factors which Bermuda finds itself in:

1. Thank you, Janet Yellen! Central banks around the world continue to pour on accommodating monetary policy. Huge quantitative easing programmes in Europe and Japan are helping to force global sovereign yields low and pinning them there. The result is that capital is sloshing around the globe looking for yield wherever it can. This has led to a bond market with less price discovery in which yields are being forced structurally lower in many cases. As a result, there appears to be an incessant bid for US Treasury securities which are actually one of the highest-yielding developed market bonds in the world. Yields on ten-year debt is trading close to multi-century lows. Everything that is priced off of this benchmark bond gets the benefit of this low rate. As a result, the 200 basis point spread offered on the Bermuda bond issue offers an attractive rate. If central banks give up at some point on aggressive monetary policy — something I think they should seriously consider — rates will inexorably drift higher. Maybe not appreciably but still higher. For example, if the ten-year bond yielded closer to 2.5 per cent, the Bermuda issue would yield about 4.5 per cent which is approximately equal to its current weighted average yield of 4.678 per cent.

2. Inflation and growth. Inflation has been missing in action throughout the developed world now for some time. In general, spare capacity has been ample, employment improving but weak, and poor demographics have lowered growth prospects through a lot of the developed world. As a result, inflationary pressures have remained dormant. This again is likely transitionary. It would appear when one looks at some leading factors like wage rate gains and spare capacity measures that inflation may be finally creeping back — more so in the US. The deflationary impact that the world enjoyed from crashing energy prices looks to be abating as well. It would not be surprising to see at least some higher inflation readings in the medium-term. Consequently, look for increased pressure on yields.

3. Institutional bid. What many people do not know is that Bermuda is often lumped in with the Caribbean and Latin America when it come to an investment categorisation. The result is that we benefit immensely from a structural “institutional bid”. A simple example will suffice to explain. Let's say you are a Latin America bond manager. You often need to invest along “benchmark guidelines” which means you may actually have to own some Bermuda debt — that is, you may be forced by the terms of the fund's prospectus to not deviate extensively from a certain benchmark weighing. Furthermore, if you do have some discretion, it is likely you would be very happy purchasing debt from an A-rated country in US dollars rather than some B- Argentina debt or even CCC+ Barbados debt. As a result there is a very nice structural bid for Bermuda debt given its perceived quality and rating. This is making it a lot easier to list and issue and possibly why the new issue was over two times oversubscribed.

The key to note is that all three of these factors are likely to be temporary and will likely revert at some point. Central banks will run out of bullets (if they have not already), inflation will reassert itself, and institutional investors will not be complacent if they continue to see escalating deficits.

This offers Bermuda a short reprieve or a window but will not fix its budget issues nor its structural growth situation over the longer-term. Debt, remember, is still rising. Although it may come at a lower cost, it is still escalating.

Annualised interest is now estimated to be about $119 million or 12 per cent of the 2016/17 budgeted revenues — an enormous amount paid and almost as much as the amount spent on education.

Gross debt of $2.54 billion is now 43 per cent of gross domestic product, which totalled $5.93 billion in 2015, and still growing. Given this debt ratio, Bermuda's ten-year productivity rate of 0.7 per cent annualised and its declining demographic workforce composition, approximately -0.6 per cent a year, plus an estimated inflation rate of 2 per cent, we still require a primary surplus of 1 per cent, excluding financing costs, to halt the escalation.

We may get there next year according to the government's estimate with some tax increases. I just hope we accomplish this through economic growth and not just tax increases.

In a nutshell, I caution any insouciance attitude in regard to our situation. The government still needs to balance the budget. Hopefully they will continue to do so with a focus on driving better efficiency, productivity and accountability throughout all government functions and less so on raising taxes that will only crush the local domestic economy further.

Nathan Kowalski CPA, CA, CFA, CIM is the chief financial officer of Anchor Investment Management Ltd and the views expressed are his own.

Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

Reprieve: the accommodative monetary policy of top central bankers like the US Federal Reserve chairwoman Janet Yellen has helped Bermuda to pay its lowest-ever coupon on government bonds

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Published October 24, 2016 at 9:00 am (Updated October 24, 2016 at 1:15 am)

Favourable bond rate gives Bermuda a window

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