(The following was released by the rating agency)
-- We believe that the Canadian banking sector is encountering incremental pressure from headwinds facing the Canadian economy, which is heightening economic risk in the banking system.
-- We also believe that industry risk for the Canadian banking sector is increasing. We expect that intensifying competition for loans and deposits will lead to pressure on profitability growth, especially in banks’ retail businesses.
-- In recognition of the bank’s strategic importance to its parent, Manulife Financial Corp. (A-/Stable/--), we are affirming our long- and short-term issuer credit ratings on Manulife Bank at ‘A+/A-1’, and lowering our stand-alone credit profile on Manulife Bank to ‘bbb+’ from ‘a-'.
-- The stable outlook reflects the stable outlook on Manulife Financial, as well as our expectation that Manulife Bank will maintain its current credit profile across a range of future scenarios.
On Dec. 13, 2012, Standard & Poor’s Ratings affirmed its ‘A+/A-1’ long- and short-term issuer credit ratings on Manulife Bank of Canada. The outlook is stable. In addition, Standard & Poor’s lowered its stand-alone credit profile (SACP) on the bank to ‘bbb+’ from ‘a-'.
The rating action follows our review of banking sector industry and economic risks in Canada, taking into account the headwinds facing the Canadian economy, high debt levels of Canadian consumers, expectations of decelerating loan demand and continued pressure on margins, particularly in the Canadian retail sector, and areas of continuing weakness in the global economy and financial system.
We believe banks operating in Canada are vulnerable to an expanding set of potential stresses arising from competitive pressure on growth and margins, while asset quality is potentially vulnerable--in light of high consumer indebtedness--to developments that may trigger general economic deterioration in Canada. Consequently, we lowered our anchor stand-alone credit profile (SACP), which is the starting point for our ratings on financial institutions operating primarily in Canada, to ‘a-’ from ‘a’. This is reflected in our revision of the Banking Industry Country Risk Assessment (BICRA) for Canada to group ‘2’ from ‘1’ and our revision of the industry risk score, a component of the BICRA, to ‘2’ from ‘1’ (see “Various Rating Actions Taken On Canadian Financial Institutions Due To Rising Industry and Economic Risks,” published Dec. 13, 2012, on RatingsDirect on the Global Credit Portal).
We believe that the banks and credit unions are under incremental pressure from the headwinds facing the Canadian economy. The acceleration of household debt to record levels has increased Canadian households’ vulnerability to sudden shocks in incomes, employment, or a spike in interest rates. Exposure to the consumer sector accounts for nearly three-fifths of total bank loans, and losses on banks’ uninsured loan portfolios--although recent performance levels have generally been strong--may be driven higher in the event of a substantial shock to household creditworthiness, though we expect effective regulatory supervision to remain a positive influence on Canadian bank credit quality.
Although we expect ongoing intensification of competitive dynamics in the Canadian banking sector, we note that overall Canada still remains positioned favorably vis-a-vis most of its global peers. However, a slowing economy risks exacerbating the already-intense competition between banks for loan and deposit share and puts further pressure on the margin and profitability of the Canadian financial institutions’ retail and commercial lending businesses, the cornerstone of Canadian banking and largest contributor to revenues. We also believe that Canadian financial institutions’ risk tolerances may increase to compensate for lower profitability by reaching for yield through investments, more aggressive lending in higher yielding loans such as personal loans and credit cards, or potentially a pick-up in mergers and acquisitions activity.
Furthermore, we expect that continuing industry conditions will test banks’ operational capabilities. Relative performance in areas such as service standards, cost control, operational effectiveness, underwriting discipline, and ability to integrate acquisitions will likely contribute to changes in market position and financial performance, and will have an impact on the relative credit standing among industry participants. The ratings on Manulife Bank reflect its revised ratings anchor of ‘a-', in conjunction with company-specific factors and group support considerations.
Standard & Poor’s bases its ratings on Manulife Bank on its “weak” business position, “strong” capital and earnings, “strong” risk position, “above average” funding, and “adequate” liquidity scores (as our criteria define them). The SACP on Manulife Bank is ‘bbb+'. Standard & Poor’s ratings also reflect our view that Manulife Bank is “strategically important” to its ultimate parent, Manulife Financial and the Manulife group. Under our group methodology criteria, the ratings on Manulife Bank are determined by this “strategically important” designation, which results in an issuer credit rating being potentially three notches above the SACP, but capped at one notch below the group credit profile. For Manulife Bank, the issuer credit rating is three notches above the SACP.
The stable outlook reflects our expectation that the Manulife Bank of Canada will continue to produce sustainable and consistent earnings, supported by its strong asset quality, low loan losses, and strong Standard & Poor’s risk-adjusted capital ratio.
Given Manulife’s concentrated exposure to the Canadian mortgage sector, and increasing share of uninsured mortgages, the ratings or outlook could come under pressure if there is a substantial rise in mortgage losses, possibly in conjunction with a return to recession with elevated unemployment levels. The rating could come under pressure if the forecasted RAC ratio were to fall below 10% over the next 18-24 months.
An outlook revision to positive would entail a more diversified earnings base, improved market share, or other signs of a strengthening market position relative to the bank’s peers, in our opinion.