Standard & Poor’s Rating Services has downgraded Butterfield Bank as a direct result of the Bermuda Government’s credit rating downgrade earlier this week.

But even as it cut Butterfield’s long-term issuer credit rating to BBB from BBB+, the rating agency noted that Butterfield had much less of a problem with bad loans than its Bermuda market competitors. S&P gave the bank a stable outlook.

S&P also commented on the bank having a weaker capital position as a result of the deal that allowed the Canadian International Bank of Commerce (CIBC) to offload its major shareholding.

Meanwhile two other rating agencies affirmed the bank’s ratings in the wake of the CIBC deal. Moody’s confirmed its A3 issuer rating on Butterfield, but changed its outlook from stable to negative. Fitch confirmed its long-term issuer default rating at A-, also with a negative outlook.

Butterfield’s downgrade by S&P comes in the wake of the same rating agency cutting Bermuda’s sovereign credit rating from AA- to A+.

S&P’s rating bakes in a “moderately high” likelihood of extraordinary Government support for Butterfield, should the bank need it.

“Nevertheless, our downgrade of Bermuda implies a somewhat weaker credit benefit to BNTB [Butterfield] from this likelihood, which we now recognise through one notch of uplift to our stand-alone credit profile (SACP) on BNTB, rather than the two notches previously applied.”

The report, the lead author of which is S&P primary credit analyst Nikola Swann, added that Butterfield’s risk position had improved, as reflected by the bank’s “sustained outperformance of other Bermuda banks in terms of loan performance in recent years, and our expectation that this will continue”.

S&P added: “For example, BNTB’s December 2014 year-end gross non-performing assets, as a share of customer loans and other real estate owned, were less than one-third of those at HSBC Bank Bermuda Ltd, Bermuda’s largest bank and BNTB’s primary competitor in the Bermudian loan market.

“Furthermore, by this measure, BNTB’s asset-quality has substantially and increasingly outperformed its Bermudian peers since 2010.”

HSBC Bermuda’s 2014 financial statements showed that more than 17 per cent of its $3 billion in loans was classified as either non-performing or impaired — that is, 90 days or more past due.

Mr Swann told The Royal Gazette that S&P also rates HSBC Bermuda, but that its A- issuer credit rating would be unaffected by the sovereign downgrade, as the “external uplift” in its ratings was based on support from the HSBC group, rather than the Government.

S&P said Butterfield had cleaned up its balance sheet through significant net charge-offs made in 2010 related to hospitality and construction loans, which included the Newstead development, contributing to better loan performance than its peers.

“We now expect this outperformance to continue, given what we consider a now well-established track record (implying stronger underwriting standards than at Bermudian peers, at least on loans made in recent years), even as we expect Bermudian asset quality in general to deteriorate through 2016,” the report added.

This week, Butterfield announced that it was paying $120 million to buy and cancel 80 million shares from CIBC for $1.50 apiece. CIBC, which helped Butterfield through a difficult time with an investment of $150 million in 2010, sold its remaining 20 million or so shares to private-equity firm Carlyle Group.

“Butterfield’s purchase of the CIBC shares represents a substantial capital outflow for BNTB, and a deterioration in our forward-looking assessment of its capital buffers,” S&P stated.

“We expect this outflow to contribute to our risk-adjusted capital (RAC) estimate for BNTB falling from its year-end 2014 level of almost 12 per cent to very close to 10 per cent, where we would expect it to remain in the 2015-2016 period, absent further capital withdrawal.”

S&P’s view tally with what Carlyle Group managing director Olivier Sarkozy, also a Butterfield director, told this newspaper five years ago — that Carlyle had a five- to seven-year window for its investment in Butterfield.

A Butterfield spokesperson said: “Given that S&P factors the potential for Government support of the industry into its ratings of Bermuda’s banks, their lowering of Butterfield’s long-term Issuer Credit Rating (‘ICR’) to BBB from BBB+ was not unexpected following their lowering of Bermuda’s long-term ICR from AA- to A+.

“We are pleased that the S&P Research Update recognised Butterfield’s improved risk position and sustained outperformance of the Island’s other banks in terms of both loan performance and asset quality since 2010, and that S&P changed the outlook on the Bank’s ICR from ‘negative’ to ‘stable’ as a result. Butterfield’s short-term ICR remained unchanged at A-2.”

In its commentary, Moody’s stated: “The rating affirmation also incorporates Moody’s expectations that Butterfield’s liquidity will remain strong and that asset quality will improve as Bermuda’s economy continues to improve.

“Historically, Moody’s had considered Butterfield’s strong capital ratio a key credit strength that helped mitigate some of the risks related to the bank’s concentrations — specifically, its real estate concentration.

“In that light, the change to a negative outlook reflects the significant decline in Butterfield’s capital after the buyout of CIBC’s equity stake, which reduces the bank’s loss absorption capacity in the short term from unexpected disappointing earnings performance.

“The negative outlook also reflects Carlyle’s ownership stake: The private-equity firm’s shorter-term investment horizon increases uncertainty about Butterfield’s longer-term strategic direction, including the bank’s capital plan.”

In its rating action statement, Fitch said Butterfield’s credit performance had continued to improve and its problem loans mix had shifted from commercial to residential mortgages. Fitch stated: “Although BNTB could face some asset quality pressures, specifically in its residential loan portfolio, Fitch expects net losses to remain manageable.”

Fitch added that Butterfield’s earnings had improved “with return on assets (ROA) and net interest margins (NIM) reflecting a positive trend”.