A rating agency brought the hammer down on Bermuda’s banking sector yesterday with a bad report card citing projected credit losses of more than a billion dollars, for a period not ending for another two years.

Standard & Poor’s took various ratings actions (see box) against two Bermudian banks, based it said, on higher economic risk.

S&P said, “We have reviewed the banking sector of Bermuda (AA-/Negative/A-1+) under our Banking Industry Country Risk Assessment (BICRA) methodology, and we now assess economic risk as higher than we previously thought.”

The agency said that real estate and other losses from non-performing loans are far more substantial and will take longer to overcome than originally expected.

The ratings report states: “We now believe full-cycle cumulative credit losses will be in the range of $1.0 billion-$1.2 billion (2009-2016), only about half of which have been realised, in light of nonperforming assets that continued to increase, as a share of total loans, in each quarter of the five most recently reported quarters (ending fourth-quarter 2013).”

S&P argues that Bermuda’s economy has weakened since the global financial markets dislocations and recession that began in 2008.

They said it is reflected in five years of continuous real declines in Bermudian GDP, the departure of several thousand non-Bermudians from the small (less than 40,000) labour force, increased and sustained unemployment among the remainder, and a very significant and extended correction in the local real estate market.

The report noted: “These factors have resulted in a substantial rise in nonperforming loans and credit risks for the banking sector, in our opinion.”

In March S&P revised Bermuda’s sovereign rating from stable to negative because of the prolonged economic downturn, deteriorating fiscal performance, and deteriorating loan performance in the banking sector.

Under S&P’s BICRA methodology, “the deterioration in economic risk lowers our anchor for ratings on banks based in Bermuda to ‘bbb-’ from ‘bbb’. This results in our lowering our stand-alone credit profile (SACP) on HSBC Bank Bermuda (HBBM), Bermuda’s largest bank, to ‘bbb-’ from ‘bbb’, and our long-term and short-term issuer credit ratings on HBBM to ‘A-/A-2’ from ‘A/A-1’.

“The ratings continue to incorporate three notches of support from HBBM’s parent, HSBC Holdings PLC (A+/Negative/A-1), as HBBM is a subsidiary that we believe remains “strategically important” to the parent.

“The CreditWatch placement followed HBBM reporting a significant deterioration in loan performance and large, discretionary dividend payments to its parent, both in 2013.

“Under our methodology, lowering our anchor to ‘bbb-’ does not affect the ratings on Bank of N.T. Butterfield & Son Ltd. (BNTB), although it does result in our SACP on BNTB likewise falling to ‘bbb-’.

“The ratings do not change because we continue to view the Government of Bermuda as “supportive” of its banking sector, and BNTB, Bermuda’s second-largest bank, as having “high” systemic importance.

“The lower anchor does mean that if we were to lower our sovereign rating on Bermuda by one notch, we would also lower our ratings on BNTB by one notch.

“We view the trend on economic risks in Bermuda’s banking industry as negative. This reflects the economic and fiscal risks encapsulated in the negative outlook on the sovereign, as well as the estimation risk surrounding our projections for full-cycle credit losses, particularly in light of nonperforming assets (NPA)-to-loan levels that are rising and (as far as we are aware) unprecedented in Bermuda.

“We expect credit losses to increase throughout 2014 and 2015 before showing signs of stabilisation in 2016. Currently high NPA levels are in sharp contrast with the Bermudian banking industry’s much stronger asset quality metrics in the decade preceding 2009.

“We view the trend for industry risk in Bermuda’s banking industry as stable. For example, we do not expect any substantial shifts in core customer deposits or the rivalry among banks — we view the latter as low given the small number of banks in Bermuda.

“Similarly, we do not expect significant alteration in the geographic or business-line diversification of Bermudian banks. Finally, Bermuda has a stable regulatory regime.

“The outlook on our ratings on HBBM is negative, reflecting the negative outlook on the ratings of its parent as well as the negative trend on Bermudian economic risk. A downgrade of the parent, evidence that Bermudian economic risk had increased further, or a reason to expect a substantial decline in our risk-adjusted capital ratio for HBBM would likely result in a further downgrade of HBBM. Stability in these factors, including a stable outlook on the ratings on the parent, would be required for a stable outlook on the ratings on HBBM.

“The outlook on our ratings on BNTB is also negative, reflecting the negative outlook on the sovereign and the negative trend on economic risk. A downgrade of the sovereign, evidence that Bermudian economic risk had increased further, or a greater-than-expected increase in BNTB’s credit losses would likely result in a downgrade of BNTB. Stabilisation in these factors, including a stable outlook on the sovereign, would be required for a stable outlook on BNTB.”

There was no comment on the report from HSBC or Butterfield last night.