Standard & Poor's yesterday changed its credit ratings outlook for Bermuda to negative from stable, citing risks stemming from the Island's banking system.

The New York-based rating agency affirmed Bermuda's AA long-term and A-1+ short-term sovereign credit ratings. It also noted that Government debt levels would rise "noticeably" over the next two years, but would remain low comparative to other countries it rates.

S&P's action comes two weeks after Moody's downgraded Bermuda Government bonds, based on the Island's small size and lack of economic diversity in the face of "external shocks".

"The outlook revision stems from what we view as risks to Bermuda's external and fiscal position from its banking system," said Standard & Poor's credit analyst Nikola Swann.

The negative outlook signals that S&P may lower Bermuda's ratings some time during the next six months to two years.

In December 2007, S&P adjusted Bermuda's outlook to stable from positive.

A downgrade of the Island's credit ratings would mean the Government would have to pay a higher rate of interest on money it borrows.

Finance Minister and Deputy Premier Paula Cox said last night that it was "great" that S&P had affirmed Bermuda's AA rating.

"I consider that the AA rating is a strong affirmation of the endurance and resilience of our economy during these challenging times," she said.

S&P's Mr. Swann concluded: "Should the Island's banking sector weaken or should the dynamism of its reinsurance market wane, the ratings could come under pressure. On the other hand, we could revise the outlook to stable if the country's external pressures ease."

In its statement, S&P said the Island's banking system services the large reinsurance sector and "is an offshore financial system in its own right".

"With external assets at 251 percent and external debt of 127 percent of GDP (gross domestic product) at year-end 2008 (by our estimates), it is large relative to the local economy," S&P said.

It added that Butterfield Bank had a 51 percent market share of deposits, but noted it had recorded $152 million in losses on its held-to-maturity investments in 2008, prompting the bank to raise $200 million of preferred shares in a Government-guaranteed capital raise.

S&P added that Bank of Bermuda, which had a 41 percent market share of deposits, had been assigned a negative outlook in December 2008, in tandem with the rating on its parent HSBC, "reflecting our expectation that HSBC's earnings and balance sheet will face greater pressure in 2009 as economic growth slows across all regions".

"Supporting the rating on Bermuda is low government indebtedness—among the lowest of rated sovereigns," Mr. Swann added. But it noted that Government was about to swing from holding a small fiscal creditor position to becoming a net general government debtor of eight percent of GDP by 2011, as the Government moves forward with its social services agenda, completes significant capital projects, and allows automatic fiscal stabilisers to operate fully.

"We expect general government deficits to rise noticeably, to five percent in 2009 and 2010 from three percent in 2008," S&P stated. "Nevertheless, we expect the country's level of indebtedness by this measure will remain lower than the ratios of most other rated sovereigns."

Minister Cox said it was understandable that ratings agencies had been conservative with respect to ratings outlooks, "given the sustained global financial and economic challenges for financial institutions in particular". She added that regulator the Bermuda Monetary Authority had been ahead of the curve by starting to conduct stress tests on banks, like those just concluded in the US, more than a year ago.

"In the recent National Budget, the Government of Bermuda included a contingency buffer under the statutory debt ceiling in the event there was a need to respond quickly to a systemic risk to an important sector of our economy," Ms Cox added.

"The Ministry of Finance was pleased to note that S&P balanced its analysis by taking a positive outlook on the resilience of Bermuda's international insurance sector and expressed the expectation that Bermuda's level of indebtedness will remain lower than the ratios of other rated sovereigns."

She added that she was "encouraged" that S&P said it may revise its ratings outlook to stable, should external pressures ease.