The National Market Exchange - NMEX

The following is a Tribune Article on the S&P Downgrade of Bahamas Bonds to Junk Status. See the full article at http://www.tribune242.com/news/2016/dec/22/bran-too-few-understand-junk-status-fall-out/

By NEIL HARTNELL
December 22, 2016

Tribune Business Editor

nhartnell@tribunemedia.net

#The Democratic National Alliance’s (DNA) leader yesterday lamented that too few Bahamians understand the ‘junk’ downgrade’s significance, and will only wake-up when Miami shopping trips are priced beyond their means.

#Branville McCartney told Tribune Business that many Bahamians would only realise what they had lost when it was “too late”, and the currency already devalued, as a result of the country’s inability to reverse its economic and fiscal course.

#The newly-appointed Senate Opposition leader likened Standard & Poor’s (S&P) action to “a charcoal present under the Christmas tree”, and predicted that it would further deter Bahamian and foreign investment in this nation.

#With domestic private sector activity likely to slow ahead of the upcoming general election, Mr McCartney predicted that the Bahamas’ loss of ‘investment grade’ status would make “very nervous and afraid” businesses even more reluctant to invest and create jobs.

#Suggesting that S&P’s ‘junk downgrade’ had placed the Bahamas in a “nerve-wracking” position, the DNA chief said ‘economic growth’ had become more a ‘turn of phrase’ than something this nation “put into effect”.

#“It’s a present from S&P. It is like charcoal under the Christmas tree,” Mr McCartney told Tribune Business of the downgrade to ‘speculative’ or ‘junk’ status.

#“Our Government was warned about this. We have seen that the Government continues to be off-base with regard to their projections for this economy.

#“There’s been nothing put in place to curb our spending and the wastage going on in this country. We can expect more of these types of downgrades if the Government doesn’t put certain measures in place to eliminate the corruption that’s going on, collect our outstanding taxes and make sure we put the VAT money where it is supposed to go.”

#Mr McCartney, though, expressed concern that many Bahamians may not appreciate the significance of S&P’s actions and how it could impact them personally, especially through reduced resources for public services, potential private sector retrenchment and job losses.

#“That is going to be the obvious cost that will probably happen as a result of the change; we’re going to have to pay more for our borrowing,” the DNA leader agreed.

#“It affects this country in every which way as a result. The unfortunate thing is that Bahamians, for the most part, don’t recognise the significance of this. The only time they will realise the significance is when they can’t go to Miami, because it costs them four times’ more, as the Bahamian dollar will be nowhere what it’s worth now.

#“That’s probably the only time they will realise and ask: What the hell has happened? By then it’ll be too late.”

#The ‘junk’ downgrade, and loss of ‘investment grade’ status, is potentially highly damaging for the Bahamas and its reputation for economic stability, as it signals to the international capital markets that this nation’s creditworthiness (the Government’s ability to pay its debts) is slipping into dangerous territory.

#The Government will likely have to pay more for current and future debt issues, raising its debt servicing (interest) costs, and sucking money away from essential public and security services

#The ‘junk’ downgrade may also deter investors assessing the Bahamas as a place to invest, as it raises questions about the Government’s economic management.

#Mr McCartney acknowledged that S&P’s ‘junk downgrade’ would make existing and potential foreign investors “think twice” about undertaking expansion projects in the Bahamas, adding this would also likely apply to locally-owned businesses.

#“Local businesses - like they were before - are likely to think twice now about investing to grow and expand,” the DNA leader added. “They’re nervous and afraid.

#“The economy typically slows before elections, but in light of this downgrade it’s going to slow even more, causing our country to be in a position where ‘economic growth’ is a term used, not something that is put into effect. It’s very nerve-wracking.”

#Mr McCartney repeated his party’s call for Prime Minister Perry Christie to make a national address outlining the practical steps the Government plans to take in response to S&P’s action, “and give us some comfort on this”.

#The Government’s initial reaction, though, was to pin all its hopes on the Baha Mar project finally opening and creating several thousand new Bahamian jobs. The rest of its statement was typically vague, and short on detail in terms of growth and job-creating initiatives.

#Slamming the Government for being ‘all talk and no action’, Mr McCartney told Tribune Business: “The Prime Minister is the best talker in the world, but when it comes to execution and getting things done, he goes into reverse.”

#Acknowledging that “the warning signs” for a ‘junk’ downgrade had been building for decades, and across both PLP and FNM administrations, Mr McCartney said S&P had indicated what the Bahamas needed to do to avoid this latest action when its representatives met with the DNA in the summer.

#“The Government did nothing, nothing, nothing,” he charged. “We’re teetering on the edge of collapse.

#“Personally, being a Bahamian, I’m very, very concerned. I know many other business persons, professionals and foreign investors who live here are concerned.

#“The Government seems devoid of ideas, and not to have the political will to get our economy back on track.”

An Interesting Comment

Here is a lesson in Downgrade101. The foreign-currency denominated sovereign bonds are held by institutions like the Royal Bank. The banks/buyers flog them to companies like Goldman Sachs. These are fixed rate, high interest bonds & with a good rating, they should be hot commodities. Buyers such as pension funds & hedge funds buy these things if the credit rating is good.

Typically what Goldman Sachs does, is buy a basket of bonds of similar types -say Caribbean Sovereign Debt. They collaterized these, meaning put them in 1 basket & sell them as investment grade securities. This is a CDO or collaterized debt obligation. They sell shares of this CDO.

Now what happens if the credit rating of the issuers of these bonds falls? The underlying financial investments -the CDO falls in value, because the danger of default rises. Holders of these buy/sell Credit Default Swaps. In other words, they buy insurance against a country defaulting on its debt. Because they buy insurance & pay monthly, this digs into the yield of the interest rate.

2 things can happen. They can push for bond redemption. This means that the government has to come up with the money to buy back these bonds. The government is already stretched for cash & if they get a bill for $300 million, then we are fooked. We don't have the cash & we can't borrow it, because our credit is shiite, so we default & that means eating pigeon & coconut for the lucky ones.

The other option is that the bond is non-redeemable. It sells for pennies on the dollar in the secondary market. They may be strip bonds with coupons, meaning that some of the interest is payable in that year before maturity. The government is also fooked in this scenario, because strip bond coupon redemption on a $300 million bond is anywhere between $15 & $30 million depending on the interest rate & we know that the government couldn't come up with the $40 million to save BoB without more debt, so we are fooked again & facing default.

The last scenario is that the bond is non-redeemable by the holder, but because the holders are buying CD Swaps or insurance, it is not worth the paper that it is printed on when that bond is either traded, or a collaterized version is traded on the secondary market. When it comes due, we are fooked again. It just puts of the bending over for a few years on just this bond.

The bottom line is that some of the debt denominated in American dollars is held as reserves by the Central Bank. If the prospect of default rises, the world's bankers will demand that we have more reserves. We can't come up with them because tourism is down, the economy is not growing & we are fooked. So the Bahamian dollar is devalued. It will probably go down to between 25 and 35 cents & some economists peg the real value at 12 cents on the US dollar. $9 Bahamian dollars will buy one US Dollar