NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of National Bank of Canada (NBC; 'A+'/'F1'; Stable Outlook by Fitch) outstanding CAD-equivalent 2.998 billion legislative mortgage covered bonds at 'AAA' with a Stable Outlook following the agency's annual review of the program.
KEY RATING DRIVERS
The rating is based on NBC's Long-term Issuer Default Rating (IDR) of 'A+', an IDR uplift of 0, unchanged Discontinuity Cap (D-Cap) of 3 (moderate high risk) and the 91.7% asset percentage (AP) that Fitch takes into account in its analysis which is equal to Fitch's 'AAA' breakeven AP. The Stable Outlook for the covered bonds rating is primarily driven by the Stable Outlook on the Canadian sovereign and on NBC's IDR.
The 91.7% 'AAA' breakeven AP, corresponding to a breakeven overcollateralization (OC) of 9.1% is driven by the cover pool's credit loss of 9.3% in an 'AAA' scenario, followed by the asset disposal loss component of 0.4% due to the refinancing spreads applied. The cash flow valuation component leads to a lower 'AAA' breakeven OC by 1.5% primarily due to the short weighted average (WA) life of the mortgages, generally three to five years, which results in a high value for the cover pool.
For this rating which considers both an uplift on a probability of default basis and for recoveries given default, the asset disposal loss component is in line with the rating scenario that is tested for timely payments (i.e. 'AA' scenario on a PD basis), while the other breakeven OC components represent 'AAA' stresses. This, plus Fitch's testing for at least 91% recoveries rather than 100% to assign two notches' credit for recoveries given default, is why the sum of the breakeven OC drivers is higher than NBC's 'AAA' breakeven OC.
The 9.3% 'AAA' credit loss represents the impact on the breakeven OC from the 20.91% weighted average default rate and the 59.35% weighted average recovery rate for the mortgage cover assets. As of September 2014, the cover pool consisted of 70,835 conventional first-lien residential mortgage loans totaling CAD 8.189 billion. The pool had a WA original combined loan-to-value of 73.3%, a non-zero WA credit score of 737 and was primarily concentrated in Quebec (63%) and Ontario (25%). The assets have a WA residual maturity of approximately 2.3 years while the covered bonds have a WA residual maturity of 5.4 years.
The unchanged D-Cap of 3 is due to the weak link assessment of systemic alternative management as 'moderate high risk'. Fitch's systemic alternative management assessment is driven by the significant roles performed post-issuer default by the guarantor, or third parties acting on its behalf. The guarantor would likely seek bondholder approval for major decisions and need to contract other parties to perform important functions. This assessment is consistent across all Canadian mortgage covered bond programs. All other D-Cap components have been assessed as 'moderate risk'.
Since bail-in is not an explicit provision under the current Canadian framework, in Fitch's view, the IDR remains a satisfactory indicator of the likelihood that the recourse against the cover pool would be enforced, and no IDR uplift is applicable.
Fitch takes into account the contractual AP maintained in the program, since amounts in excess of the contractual commitment are secured back to NBC through the demand loan and therefore not available to covered bond holders in the event of issuer default.
The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) the IDR is downgraded by two or more notches to 'A-' or below; or (ii) the number of notches represented by the D-Cap is reduced to 1; or (iii) the AP that Fitch considers in its analysis increases above Fitch's 'AAA' breakeven level of 91.7%.
The Fitch breakeven AP for the covered bond rating will be affected by, among others things, the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuance. Therefore, the breakeven AP to maintain the covered bond rating cannot be assumed to remain stable over time.
More details on the portfolio and Fitch's analysis will be available in a credit update report, which will shortly be available at www.fitchratings.com.
In the report 'Breaking Down Breakeven Overcollateralisation', published 8 July 2014 and available at www.fitchratings.com, Fitch details its approach for determining the breakeven OC components.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--Covered Bonds Rating Criteria (August 2014)
--Counterparty Criteria for Structured Finance and Covered Bonds (May 2014)
--Counterparty Criteria for Structured Finance and Covered Bonds: Derivative Addendum (May 2014)
--Covered Bonds Rating Criteria - Mortgage Liquidity and Refinancing Stress Addendum (February 2014)
--Canadian Residential Mortgage Loan Loss Model Criteria (May 2014)
Applicable Criteria and Related Research:
Canadian Residential Mortgage Loan Loss Model Criteria
Covered Bonds Rating Criteria - Mortgage Liquidity and Refinancing Stress Addendum
Counterparty Criteria for Structured Finance and Covered Bonds: Derivative Addendum - Effective from 13 May 2013 to 14 May 2014
Counterparty Criteria for Structured Finance and Covered Bonds
Covered Bonds Rating Criteria