Morningstar DBRS Assigns 'A' Credit Ratings to Bermuda, Positive Trend

DBRS, Inc. (Morningstar DBRS) assigned to Bermuda Long-Term Foreign and Local Currency - Issuer Ratings of 'A'. At the same time, Morningstar DBRS assigned to Bermuda Short-Term Foreign and Local Currency - Issuer Ratings of R-1 (low). The trend on all credit ratings is Positive.

KEY CREDIT RATING CONSIDERATIONS
The Positive trend reflects Morningstar DBRS' view that Bermuda's steady improvement in public finances and robust growth outlook will likely reduce credit risk. The government has run prudent fiscal policy over the last decade, including expectations for a balanced budget in FY 2024/25 and a small surplus in FY 2025/26. The government debt-to-GDP ratio appears to be on a downward trajectory. At the same time, Bermuda's economy has performed well over the last few years, supported by a robust expansion in the international business sector and a steady recovery in the tourism sector. The government forecasts the economy to grow between 4.3-4.5% for 2024. Achieving growth and fiscal targets could warrant an upgrade of the credit ratings. Furthermore, Bermuda may reduce its debt burden more rapidly than expected. In December 2023, the government enacted the Bermuda Corporate Income Tax Act of 2023, which establishes a 15% corporate income tax on business entities in Bermuda linked to multinational enterprises. Early estimates suggest that the new corporate income tax law could provide a boost to government revenues. The upper range of total corporate income tax receipts is estimated at around 10% of GDP annually, although receipts will be moderated after incorporating offsetting tax measures. However, there is uncertainty about how the new tax will be implemented. The government has indicated that part of the excess generated revenue, if any, could be used for early repayment of government debt, which would be positive for the credit rating.

Bermuda's `A' credit ratings are supported by the country's high GDP per capita, strong fiscal track record, and stable political environment. Per capita income in Bermuda is among the highest in the world, in part due to its outsized role in the global insurance/re-insurance sector. Effective public institutions, stable domestic politics, and a legal system based on English common law all promote Bermuda's attractiveness as an international financial center. In Morningstar DBRS' view, these strengths counterbalance the credit challenges associated with the country's very small and relatively concentrated economy, as well as its limited monetary flexibility due to the pegged exchange rate.

CREDIT RATING DRIVERS
The credit ratings could be upgraded if Bermuda's fiscal position continues to improve, thereby putting the government debt-to-GDP ratio on a firm downward trajectory. The trend could return to Stable if the fiscal outlook deteriorates relative to current expectations.

The credit ratings could be downgraded if (1) the fiscal position deteriorates significantly; or (2) an adverse shock to the international business sector occurs, especially for the international insurance and reinsurance activities, which weakens economic growth prospects.

CREDIT RATING RATIONALE

Bermuda's Economy Is Experiencing Solid Growth; But Limited Economic Diversification Is A Vulnerability

Bermuda's economy continues to recover from the pandemic. Growth continues to be driven primarily by the international business sector, the largest sector of the economy. The tourism sector is also recovering, but more gradually, with increased air capacity and hotel inventory expected to come online in 2024. The Ministry of Finance estimates that the economy grew 4.0-4.5% in 2023. Economic growth has been supported in part by the implementation of the government's post-pandemic Economic Recovery Plan (ERP), which aims to diversify Bermuda's economy and build critical new infrastructure. Government growth forecasts for 2024 range between 4.3-4.5%. Over the medium term, Bermuda faces several downside risks to growth. The new corporate income tax may eventually reduce Bermuda's attractiveness as an insurance/reinsurance hub, although this risk is mitigated by Bermuda's advanced regulatory framework with equivalence in the U.S. and the EU, its knowledgeable workforce, and high level of competition spurring innovation, all of which are compelling factors for the insurance industry to remain in Bermuda. In addition, Bermuda faces an aging and shrinking population, which is coupled with emigration of the educated workforce. Rising costs of living could also affect affordability for residents and contribute to higher labor costs, thereby reducing the competitiveness of the tourism and the international business sectors.

Although Bermuda has one of the highest income economies in the world on a per capita basis, Bermuda's ratings are constrained by the small size of the economy and limited economic diversification, both of which leave the country vulnerable to external shocks. Nominal GDP totaled USD 7.5 billion in 2022, making it one of the smallest national economies rated by Morningstar DBRS. The economy is highly concentrated in two sectors: tourism (which accounts for 5% of GDP directly, 18% indirectly, and 9% of employment), and the international business sector (which accounts for 28% of GDP and 15% of employment). Economic growth was stagnant in the decade prior to the pandemic. Initially, this was due to the lingering effects of the global financial crisis, and later from the changing structure of the tourism sector. Between 2015 and 2019, the economy grew on average by 0.7% per year, despite the strong performance of the international business sector.

New Corporate Income Tax Could Improve The Fiscal Accounts, But Increases Reliance On A Single Sector

Bermuda's track record of prudent fiscal policy is a credit strength. The fiscal deficit has been shrinking since 2013, although the pandemic-related measures briefly caused the deficit to rise to 2.7% of GDP. Stronger-than-expected payroll tax receipts in recent years, coupled with limited growth in expenditures, has enabled the government to close the gap. Early estimates show the government achieving a slight deficit of 0.6% of GDP in FY 2023/24. Furthermore, the first balanced budget in over two decades is projected for this fiscal year.

The new corporate income tax could provide a boost to fiscal revenues in the near term. The 15 percent corporate income tax (CIT), a level in line with the OECD/G20's global minimum tax, is scheduled to take effect in January 2025. The government estimates that the government could receive up to 750 million dollars annually in corporate tax receipts (close to 10% of 2023 GDP). However, significant uncertainties remain around the CIT, such as the scale of receipts, potential offsetting tax credits, spending priorities, and the broader plan for tax reform. Additionally, government revenues are increasingly reliant on the international business sector. In addition to the corporate income tax, the government has reduced payroll taxes four times since taking office in 2017, with the bulk of the savings aimed towards the lower income bands, local businesses, and self-employed farmers and fishermen. As a result, the share borne by high-income earners, generally employed by the international business sector, has been increasing, which could leave public finances vulnerable should the sector decline or relocate business to other jurisdictions.

Bermuda's government debt ratio is projected to slowly decline over the next several years, even before accounting for potential effects of the new corporate income tax, due to solid economic growth and the government's success in consolidating fiscal accounts. After peaking at 49% in 2020 (BMD 2.5 billion), the government debt-to-GDP ratio declined to 42% in 2023 (BMD 3.2 billion). The government benefits from funding through local banks and the international bond market. The maturity profile is favorable, with the average maturity around 10 years. While all of the government's debt is denominated in U.S. dollars, exchange rate risk is mitigated by the credibility of the pegged exchange rate. The next redemption is due in early 2027, meaning the government will probably not need to go to the markets for financing over the next three years.

However, the moderate debt-to-GDP ratio understates debt sustainability risks. Debt metrics relative to government revenues are less favorable: government debt accounted for close to 270% of revenues and interests costs for 12% of revenues in 2023. The fiscal guardrails established by the government aim to reduce government debt to less than 80% of revenues and debt service below 10% of revenues. Additionally, the government has substantial contingent liabilities in the form of government guarantees to commercial projects which amount to BMD 959 million (12% of GDP Of the remaining guarantees, the Bermuda Hospitals Board is the most significant (BMD 758 million, around 10% of GDP), although there are two hotel development projects covered as well. These factors underpin our negative qualitative adjustment to the `Debt and Liquidity' building block assessment.

Bermuda's Capacity For External Adjustment Is Limited But The External Position Is Strong

Bermuda runs consistent current account surpluses, which are primarily driven by the international business sector (via employee compensation) and the tourism sector. The surplus has averaged 13% of GDP over the last decade, which has contributed to Bermuda's net international asset position at around 43% of GDP (as of Q3 2023). Nevertheless, Bermuda's capacity for external adjustment is constrained by the fixed exchange rate, elevating the importance of sound macroeconomic policies in order to maintain external competitiveness.

The Bermudian Banking Sector Is Well-Capitalized

Inflation continues to fall in Bermuda, with the annual inflation rate standing at 2.4% as of September 2023. Government policies, such as a freeze on fuel prices and the elimination of duties on staple goods, have contributed to the decline. We expect the disinflationary trend to continue due to the influence of tight monetary policy stance in the U.S. and the decline in global commodity prices. Bermuda does not have a central bank and does not conduct its own monetary policy. Domestic interest rates are set by the market and regulated by the Ministry of Finance, and generally follow rates set by the U.S. Federal Reserve. The Bermuda Monetary Authority is the local financial supervisor for financial services.

Bermudian banks continue to be well-capitalized and hold ample liquidity, which should enable the sector to weather potential liquidity stresses. According to Bermuda Monetary Authority data, the average Basel III-calculated CET1 capital ratio stood at 24.2% in Q3 2023. The ratio of non-performing loans to total loans remained steady at 5.3% in Q3 2023. Rising interest rates have also improved banking sector profitability. However, credit to the private sector is limited and mainly in the form of residential mortgages, which account for close to 55% of total loans. Moreover, the level of public information available regarding the characteristics of the Bermudian real estate market is limited, and there is limited data on property prices. This is also the case regarding our measure of the level of domestic savings, given that the only publicly available data is for total customer deposits, which includes non-residents. These data-related issues underpin our negative qualitative adjustments to the `Monetary Policy and Financial Stability' building block assessment.

Bermuda's Ratings Are Supported By Strong Institutions And A Stable Political Environment

Bermuda benefits from effective public institutions and a stable political environment, as demonstrated by its relatively high rankings on the Worldwide Governance Indicators. Bermuda is one of the 14 Overseas Territories (OT) of the UK. While Bermuda has its own constitution, government, and local laws, the UK Parliament has "unlimited power to legislate" for it. As a UK OT, Bermuda benefits from the institutional strengths and support of the UK, ranging from budgetary assistance and technical support to defense and security issues.

Two political parties historically dominate the political spectrum: the Progressive Labour Party (PLP) currently in power and the One Bermuda Alliance (OBA), successor of the United Bermuda Party (UBP). The PLP currently holds 30 of 36 seats in the House of Assembly, meaning that the government faces little opposition in carrying out its policy agenda. Under the PLP, Bermuda is pursuing full Caricom membership, which would deepen Bermuda's economic integration into the Caribbean. Caricom aims to establish the Caribbean Single Market and Economy (CSME) which would enable the free movement of goods and services, capital, and people. Other items on the PLP agenda include increasing climate resilience, and further reforming tax and immigration policy. Next elections are due by October 2025.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG Considerations had a relevant effect on the credit analysis.

Environmental (E) Factors

The following Environmental factors had a relevant effect on the credit analysis: Climate & Weather Risks. Like most small islands over the globe, Bermuda's infrastructure is relatively more exposed to the potential impact of climate change. According to the Bermuda Weather Service, one hurricane approaches Bermuda every year, and one severe hurricane is likely to hit Bermuda every 5 to 7 years. However, catastrophic damage has been historically rare.

There were no Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://dbrs.morningstar.com/research/435136.

Notes:
All figures are in U.S. dollars unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (06 October 2023) https://dbrs.morningstar.com/research/421590. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

The primary sources of information used for this credit rating include the Bermuda Monetary Authority, Bermuda Ministry of Finance, Bermuda Department of Statistics, Bermuda National Trust, Bermuda Fiscal Responsibility Panel, IMF, World Bank, UN, and Haver. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings was of satisfactory quality.

The credit rating was not initiated at the request of the rated entity. The credit rating was initiated at the request of a third party.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS did not have access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

These credit ratings concern a newly rated issuer. These are the first Morningstar DBRS credit ratings on this issuer.

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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