Bermuda’s Sovereign Ratings Explained

22 September 2010

Fitch Ratings recently affirmed Bermuda’s long-term foreign currency rating of ‘AA+’, the second highest rating on the Agency’s relative scale. The Outlook on Bermuda’s ratings is Stable. This article discusses the significance of Bermuda’s rating and the primary factors underpinning the jurisdiction’s sovereign creditworthiness.

What is a sovereign rating?

Fitch‘s sovereign ratings are a forward-looking, qualitative and quantitative assessment of the sovereign’s capacity and willingness to honor its existing and future obligations in full and on time. Bermuda’s high-grade rating indicates that in Fitch’s opinion, the “probability of default” is quite low.

How are sovereign ratings determined?

Given the significance of the government and public sector as a whole to the national economy, the activities and policy actions of the sovereign have a profound impact on and are influenced by the performance of the economy as a whole. As such, Fitch’s sovereign rating analysis incorporates a wider range of factors than only the financial strength of the sovereign. Fitch’s sovereign credit and rating analysis focuses on the following factors:

• Macroeconomic performance and prospects;
• Structural features of the economy that render it more or less vulnerable to shocks as well as political risk and governance factors;
• Public finances, including the structure and sustainability of public debt as well as fiscal financing;
• The soundness of the financial sector and banking system, in particular with respect to macroeconomic stability and contingent liability for the sovereign; and
• External finances, with a particular focus on the sustainability of international trade balances, current account funding and capital flows, as well as the level and structure of external debt (public and private).

Fundamental to Fitch’s sovereign rating methodology is rigorous peer analysis. Indicators of sovereign creditworthiness are compared across countries and over time. It is evident, however, that there is not a simple linear relationship between sovereign ratings and every metric that Fitch considers in its rating analysis. In part this reflects qualitative factors that influence the ability and willingness of a sovereign to honor its financial obligations. These ‘intangible’ influences on sovereign creditworthiness include high levels of human capital, strong institutions, and respect for the rule of law and property rights, stable and flexible political systems responsive to economic and social pressures, as well as very wealthy (including in the quality and stock of capital) and diversified economies.

How does Bermuda stack up?

A high per capita income of over US$97,000, low public debt burden and effective management of the business and economic environment afford additional support to Bermuda’s Sovereign ratings. Bermuda’s key credit weakness is the economy’s lack of economic diversification and small size, which curbs the capacity to absorb extreme shocks relative to other high-grade sovereigns. Bermuda’s ‘AA+’ peers currently include Australia, Belgium, Ireland and New Zealand. Much of Western Europe, Canada, Singapore and the US make-up the ‘AAA’ peer group, while Japan and Portugal are notable ‘AA’ credits.  

As a small island economy, Bermuda is vulnerable to external dynamics, such as commodity price shocks and economic downturn in trading partners. As a result, Fitch expects GDP to contract by 2.0% in 2009 before recovering moderately in 2010. However, a strong track record of macroeconomic stability and large current account surpluses bolster the island in the face of global economic and financial turbulence.

In addition, Bermuda has not been exposed to global and local financial market distress to the same degree as other high-grade peers. Financial system supervision continues to improve and uphold high international regulatory standards. Bermuda’s well-established reputation as a domicile of choice for (re)insurance and financial services companies provides a basis for sustainable economic growth.

A longstanding commitment to prudent fiscal policy underpins Bermuda’s creditworthiness and provides a strong starting position for facing the global economic crisis. However, in the absence of greater policy flexibility, the fiscal policy response to global recession has resulted in some slippage. Although Bermuda’s government debt ratios still compares favorably with those of ‘AA’ peers and 10-year category medians, a lower debt burden is prudent given the government’s low revenue base and more limited financing options relative to other high-grade peers.

What could drive a change in Bermuda’s ratings?

Sizeable fiscal slippage which results in a sustained increase in the sovereign’s public debt burden could put downward pressure on Bermuda’s ratings in light of limited financing flexibility. However, an expansion of Bermuda’s balance sheet intended to backstop the financial system appears highly unlikely. Contrary to the experience of other high grade sovereigns, the island’s banks have not required public sector capital injections to weather the global crisis thus far. 

Changes to Bermuda’s tax regime, whether originating domestically or abroad, which result in erosion of the territory’s attractiveness as a domicile for international companies could also be negative for creditworthiness.

On the other hand, fulfillment of the Government’s expressed commitment to fiscal consolidation and debt reduction when the economy recovers would help uphold Bermuda’s ratings.

Further information regarding Bermuda’s sovereign ratings and Fitch’s sovereign rating methodology is available at www.fitchratings.com.