Dominion Bond Rating Service assigned ratings on Manulife Bank of Canada today, citing the strength of its parent company. However, the ratings agency cautioned that funding is one of the bank’s central challenges.

DBRS today assigned R-1 (middle) and AA (low) ratings to the non-guaranteed short-term and issuer, long-term deposits, and senior debt ratings, respectively, of Manulife Bank. The short-term bearer and long-term deposit notes (guaranteed by The Manufacturers Life Insurance Co.) have also been confirmed at R-1 (middle) and AA, respectively. The trends are “stable”, DBRS says.

“Notwithstanding the absence of any formal guarantees, the stand-alone ratings and trends of Manulife Bank reflect the strength of The Manufacturers Life Insurance Co., including strategic alignment, branding, significant cross-relationships both on management and systems, reliance on The Manufacturers Life Insurance Co.’s relationships with agents for asset gathering and some funding,” DBRS said.

The rating agency said it believes the credit strength of Manulife Bank should be close to the ratings of its parent due to: the base strength and conservatism of the bank’s business model and financial metrics; the support it receives from, and strength of, its parent; and the fact that the parent company has stated to DBRS that it fully expects to support Manulife Bank under all circumstances.

“However, it is difficult for explicit support to match the clarity and legality of an unconditional guarantee,” it noted. DBRS says it considers this difference to be worth one notch on the long-term rating scale for Manulife Bank.

DBRS also said it believes one of the more noteworthy challenges for Manulife Bank, “is the significant dependence of funding (mainly deposits) raised through independent insurance agents and financial advisors across Canada. Manulife Bank attracts deposits from these channels using competitively priced products. Funding risk is an ongoing challenge, but is largely mitigated with access to the parent should funding needs arise.”

DBRS expects earnings growth to remain strong in the near to medium term, “as Manulife Bank continues to generate asset growth and focus on improving its already low expense ratio”. It reported that net income has steadily grown from $4.8 million in 2000 to $16.4 million in 2004, resulting in a compound annual growth rate of 27% over this time period. Return on equity (2004) was 17.0%, which is comparable to other highly rated banks.

In 2004, 96% of revenue was derived from net interest income, which leaves the bank susceptible to spread compression, DBRS noted. “So far, Manulife Bank has negated the impact on profitability through asset volume growth and an efficient delivery system. As the bank does not have branches and spends little on marketing, the efficiency ratio is significantly better than those of comparable peers,” it added.

“The asset quality profile is conservative and DBRS anticipates it will continue to remain so, given the bank’s strategy to continue to grow in lower risk asset classes of residential mortgages and secured investment related lending,” it said. It reports that at the end of 2004, the loan portfolio was concentrated in retail loans (95%). Within retail loans, 61% are residential mortgages and the remainder are in secured investment-related lending. “Because of the loan composition, the credit quality ratios are strong and credit costs remain low,” it added.