The Tribune

By Richard Coulson

Major changes in the financial game often creep up almost unnoticed, without fanfare or formal proclamations. That’s what’s happening in the Bahamas.

The latest signal was the recent announcement by our banks that their interest rate for ordinary demand deposits is reduced from 1.25 per cent to 0.5 per cent, an abrupt decline of over 50 per cent to the lowest level in living memory. For thousands of Bahamians who have relied on a bank deposit, liquid and pretty safe, to park their cash and give them a modest return - well, they’re now out of luck. Keeping cash under the proverbial mattress has become not a bad option, given the fees that any bank charges just to maintain an account.

Even a customer fortunate to have $100,000 to place on term deposit for a year is lucky if he is offered 2.5 per cent (usually less), lower than our rate of inflation, however it is measured. So the value of money is being lost while it sits in your bank. It is surprising that lines in front of cash machines are not longer - why not withdraw and spend before prices go up? Savers face the same dilemma in the US, where the deposit interest is even lower than here.

We are not blaming the banks for this state of affairs. It is simply another sure sign that we are in a recession. Banks are not finding credit-worthy new loans, which is where they make their money. As interest income received dries up, naturally they must reduce the cost of their raw material by lowering interest paid on deposits. And, to be fair, the interest they charge on overdrafts, commercial loans and mortgages has been gradually dropping. One lender is now charging only 7.75 per cent for a home mortgage, and sometimes 7 per cent for a good customer.

Of course, there must always be a profitable spread between interest received and interest paid, or banks would go out of business. In 2011, Commonwealth Bank recorded interest income of $164 million and interest expense of $48 million, an attractive multiple of 3.41X, before reflecting a hefty $25 million charge for loan impairment. How will this multiple change in 2012, as the bank adjusts to our new climate of lower rates, and will loan quality improve so the impairment charge can be reduced?

For the saver, large or small, the question is different: Simply, what to do with excess cash? We wonder what banks, with all their cheerful publicity about “helping you build a nest egg, pay college fees, save for retirement, etc.”, are actually advising their customers. It would be almost criminal to advise simply keeping funds on deposit. Preferred stocks or corporate bonds with attractive yields are so rare as to be almost unobtainable; their owners have no interest in selling. Government securities represent a peculiar market we shall discuss later. The only alternative is to consider equities - the publicly quoted shares traded on BISX, or the few mutual funds investing in these shares.

This will be a new experiment for many Bahamians, who have usually considered shares as investments strictly for well-endowed pension funds or wealthy citizens willing to take a flier with monies they will never need again. Only rarely, as in the Arawak Port IPO, have small investors taken much interest. But we believe this attitude is starting to change. The dividend yield on some of our most active shares is now at 4-5 per cent or even higher, with one of our stronger companies now indicating close to 7 per cent. Of course, ordinary dividends are not fixed and can decline, but savers are beginning to recognise their advantages over bank deposit rates, even before factoring in possible capital gains from price appreciation.

One major drawback to investing in our stock market has always been its illiquidity. With low trading volumes, having bought, can you sell? But the daily trading statistics given by Royal Fidelity suggest a gradual increase in trading over the last six months. For example, on a recent day the shares of nine listed issuers traded with a total value of about $158,000. Since only one issuer recorded a price decline, the day’s trading was not marked by ‘distress selling’, and sellers were well matched by buyers. It seems that long-somnolent market forces are coming to life as more investors, no longer lured by bank deposits, enter buy orders through their brokers. Increased trading should be a self-feeding process that leads to even more trading. It will be a slow process, but may cause more companies, or their shareholders, to ‘go public’ and thus provide even greater trading opportunities.

BISX has already been successful in adopting efficient IT programmes and creating the Central Securities Depositary to handle seamless settlement of inter-party trades, but it could take more steps to accelerate the gradually increasing investor interest in equities. First, it could improve how information about trading and pricing is presented on its website, as it currently tells nothing about trend lines. Second, it could at last implement a listing and trading platform for smaller, newer companies, a project that it has discussed for several years, but without any final decision.

But the biggest step to help BISX expand its services, and to modernise our entire investment structure, lies in the hands of Government. What’s needed is a complete revamping of the traditional system by which our national bonds (Bahamas Government Registered Stock, or BGRS) are sold. We now have over 50 issues of BGRS outstanding, totalling nearly $2.6 billion, of different maturities and bearing floating-rate interest set at varying levels above our prime rate, presently 4.75 per cent. At these high yields, they should be actively trading in an open market, at prices well above par value. But, in fact, they do not trade at all. The Board and management of BISX have continually asked Government to allow these securities to be listed on BISX, so that their original issuance and trading could be handled by our private sector banks and broker/dealers.

But for reasons never made clear, Government has kept these functions locked into the Central Bank, which has no capabilities for wide securities marketing, distribution or trading. Thus, the BGRS are sold directly to institutions who must apply in a brief offering period that is barely noticed by retail investors. Once issued, the BGRS are in effect ‘frozen’. Instead of instantly trading in an openly quoted market, BGRS can only be bought through a cumbersome procedure of applying to the Central Bank. Thus there is no established market price to use as a benchmark, no ‘yield curve’ for varying maturities of Government debt, the strongest credit in the country.

Government has just launched a BGRS offering totalling $200 million, in nine series ranging from five to 19 years, available from the Central Bank for four business days. We see one sensible change from past practice: the new BGRS carry fixed-interest coupons from 4 per cent to 4.35 per cent, depending on maturity. However, we wonder whether Government is not paying too much. The risk/reward ratio seems askew when sovereign debt yields as much as dividends on corporate shares. The BGRS rates are much higher than available on local bank deposits or CDs. In the US, by contrast, treasury bonds pay substantially less than bank obligations – three-year treasuries at 0.40 per cent compared to CDs at 1.2 per cent.

Government might have set a lower rate by consultation with a Primary Dealers Committee of banks and securities dealers, who would then commit to underwrite the BGRS and distribute them to their institutional and retail customers. Since there would probably be large new retail demand, a yield might have been set that would be much more attractive than bank deposits, while lower than the 4 per cent level. With wide distribution, and listing on BISX, the new BGRS could then trade feely in the after-market at a premium or a discount to reflect market interest rates as determined solely by supply and demand, not by Government fiat. And for the first time we would have a pool of liquid, high-credit securities that could satisfy both buyers and sellers seeking immediate cash or immediate investment.

An active bond market would also have an indirect but positive effect on our equities market. Our securities dealers would have contact with a wider group of investors, and the fees and commissions from dealing in BGRS, even at the low percentages normal for bond trades, would increase revenues for both dealers and for BISX. This would allow more expenditure for educating and informing the Bahamian public about investments through all modern media, including real-time TV, radio, I-phone and Internet dissemination of market news. At long last, we would begin to approach the active fixed-interest markets, for short-term liquidity or predicable yield, and the equity markets for long-term investments, that already exist from Brazil to Australia, even in such small markets as Costa Rica. A framework for a newly-vibrant capital markets is not the only step required to lift us from recession, but it is surely an essential one.