NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of Bank of Nova Scotia's (BNS; 'AA-'/'F1+'; Stable Outlook) outstanding CAD-equivalent 16.38 billion registered mortgage covered bonds following our annual review of the program at 'AAA'; Stable Outlook.
BNS has indicated that it will lower its contractual asset percentage (AP) to 93% for its registered mortgage covered bond program, which is in line with Fitch's calculated breakeven AP for the 'AAA' rating. Fitch's breakeven AP decreased to 93% from 93.5%, which is below the 93.5% AP used in the asset coverage test currently reported in the monthly investor report. BNS indicated that it will amend the contractual AP in its next monthly report. The amendment, taken together with BNS' Long-term Issuer Default Rating (IDR) of 'AA-', the unchanged IDR uplift of N/A, and the unchanged Discontinuity Cap (D-Cap) of 3 notches (moderate high risk), all support the covered bonds' 'AAA' rating.
KEY RATING DRIVERS
The rating is based on BNS' Long-term IDR of 'AA-', an unchanged D-Cap of 3 (moderate high risk) and the 93% AP that Fitch takes into account in its analysis which equals Fitch's 'AAA' breakeven AP. The Stable Outlook is due to the Stable Outlook on the Canadian sovereign rating and on BNS' IDR. Since bail-in is not an explicit provision under the current Canadian framework, the IDR remains a satisfactory indicator, in Fitch's view, of the likelihood that the recourse against the cover pool would be enforced, and no IDR uplift is applicable.
The 93% AAA' breakeven AP, corresponding to a breakeven overcollateralization (OC) of 7.5%, is driven by the cover pool's credit loss of 9.3%, followed by the asset disposal loss component of 0.6% due to maturity mismatches in a 'AAA' scenario. The cash flow valuation component adds to 'AAA' breakeven OC by 0.6% 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. The breakeven AP considers whether timely payments are met in an 'AA' scenario and tests for recoveries given default of at least 91% in a 'AAA' scenario.
The 9.3% 'AAA' credit loss represents the impact on the breakeven OC from the 20.9% WA default rate and the 59.3% WA average recovery rate for the mortgage cover assets. This reflects an increase in the 'AAA' credit loss from Fitch's prior analysis of 7.2% due to the cover pool's lower credit score distribution.
Fitch's 'AAA' credit loss considers an adjustment to borrower's credit scores to account for use of Transunion's FICO8 score vs Equifax's BEACON score, on which the agency's Canadian residential mortgage loan loss model is based.
Fitch takes into account the contractual AP maintained in the program, since amounts in excess of the contractual commitment are secured back to BNS through the demand loan and therefore not available to covered-bond holders in the event of issuer default.
Canadian covered bond program documents include a feature called the Selected Assets Required Amount (SARA) clause, which places some conditions on the sale of assets in the event of an issuer default. Fitch has considered the impact of this clause by modelling an issuer default in each of the first six quarters and before the first benchmark covered bond maturity and determined that the overcollateralization level is sufficient for all possible sale periods under a given rating scenario.
The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) the IDR is downgraded by three or more notches to 'A-' or below; or (ii) the number of notches represented by the D-Cap is reduced to 0; or (iii) the AP that Fitch considers in its analysis increases above our 'AAA' breakeven level of 93%.
The Fitch breakeven AP for the covered bond rating will be affected, by, among other factors, 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 needed to maintain the covered bond rating cannot be assumed to remain stable over time.
More details on the cover pool and Fitch's analysis will be available in a credit update report, which will be available shortly at www.fitchratings.com.
Additional information is available on www.fitchratings.com
Canadian Residential Mortgage Loan Loss Model Criteria (pub. 16 Apr 2015)
Counterparty Criteria for Structured Finance and Covered Bonds (pub. 14 May 2014)
Counterparty Criteria for Structured Finance and Covered Bonds: Derivative Addendum (pub. 14 May 2014)
Covered Bonds Rating Criteria (pub. 11 Mar 2016)
Criteria for Interest Rate Stresses in Structured Finance Transactions and Covered Bonds (pub. 19 Dec 2014)
Global Structured Finance Rating Criteria (pub. 06 Jul 2015)
Dodd-Frank Rating Information Disclosure Form