Dominion Bond Rating Service has initiated coverage of TD Banknorth Inc.

The rating agency states that Banknorth’s ratings are based on majority ownership by the financially strong TD Bank Financial Group and a sound New England community-focused banking franchise that features a healthy core deposit base. Strong asset quality and a solid record of successful bank integrations over the past 15 years also support the ratings, it adds.

DBRS noted that the ratings also incorporate anemic profitability, below-peer capitalization levels, challenges associated with the pending acquisition and integration of the less robust Hudson United Bancorp franchise, as well as issues regarding the management of interest rate risk.

TD purchased a majority stake in Banknorth for US$3.8 billion (60% cash and 40% stock) in March 2005, giving Banknorth the TD brand name and the potential to draw upon a sizeable resource. Implicit in the ratings is DBRS’s expectation that TD has the resources and motivation to support Banknorth in the unlikely event that financial assistance is necessary, it says. Without the support of its majority shareholder, Banknorth would likely be rated at a lower level.

DBRS indicates that it expects Banknorth’s share of the consolidated balance sheet and net earnings to grow over the medium to long term as it expands its franchise, primarily through acquisition. TD’s commitment to Banknorth and its U.S. expansion strategy is made more evident by the guaranty of a US$228 million subordinated debt issuance in September 2005, it adds.

On January 31, Banknorth closed a deal for Hudson United, adding over 200 branches and providing entry into the New York and Philadelphia metropolitan areas, in addition to New York’s Hudson Valley region. “While Hudson United has a similar focus on small- and middle-market businesses, it will introduce Banknorth to new products, geographic markets and competitors,” it notes. “The company may also be challenged with expanding Hudson United’s nascent deposit market shares and lowering its higher deposit costs against deeply entrenched competitors who are also committed to the region.” In DBRS’s opinion, Banknorth’s considerable integration expertise coupled with TD’s capital resources and patience will be necessary for Banknorth to penetrate these new markets.

The rating agency reports that in January, Banknorth announced its third balance sheet restructuring or deleveraging within the past 16 months. It says it believes that Banknorth’s actions reflect the shift from its traditional style of interest-rate risk management to TD’s practice. “Therefore, DBRS expects both lower yields and less volatility from the company’s securities portfolio in the future.”