NEW YORK & LONDON--(BUSINESS WIRE)--Fitch Ratings has assigned the National Bank of Canada's (NBC; rated 'A+/F1', with a Stable Outlook) USD1 billion series 1 issue of mortgage covered bonds a 'AAA' rating. The fixed-rate paying bonds, which mature in three years, are guaranteed by NBC Covered Bond Guarantor LP, a special purpose trust established for the programme.
The rating is based on NBC's Long-term Issuer Default Rating (IDR) of 'A+' and a Discontinuity Factor (D-Factor) of 17.4%. This combination enables the covered bonds to reach 'AA+' on a probability-of-default (PD) basis. Also the overcollateralization (OC) is expected to be sufficient to sustain this level of stress, and 'AAA' on a recovery basis after giving one-notch credit for outstanding recovery prospects in a 'AAA' rating scenario. NBC's covered bond rating could still be maintained at 'AAA' if the issuer was rated as low as 'BBB+', all else being equal.
Fitch D-Factors measure the likelihood of payment interruption upon an issuer default. The D-Factor assigned to NBC's mortgage covered bonds reflects the comfort gained from the segregation of the cover assets in the bankruptcy remote special-purpose trust acting as guarantor, the adequate provisions for the guarantor to take appropriate decisions post issuer default and its ability to do so, aided by the satisfactory level of sophistication of NBC's IT systems. The D-Factor also incorporates Fitch's assessment of the liquidity gaps that could arise in the immediate aftermath of a potential default of the issuer, while the guarantee is being exercised. Fitch deems a six-month time horizon for liquidation in a stressful scenario to be feasible because the mortgages are insured by Canada Mortgage and Housing Corporation (CMHC) and therefore eligible for repackaging into National Housing Act mortgage-backed securities (NHA-MBS) and the Canada Mortgage Bond (CMB) programme. The bonds will have a 12-month extendable maturity effective when recourse to the issuer is no longer available, which would provide strong liquidity protection following an issuer default. In Fitch's view, covered bondholders would not benefit from Canadian banking authorities intervening in their interest, due to the lack of specific regulation.
In Fitch's stressed cash flow modeling the asset percentage (AP) supporting the rating currently stands at a maximum of 93.5% (i.e. if total outstanding covered bonds represent 93.5% or less of the total cover pool). A major driver of the high supporting AP is the short tenor of the cover assets which is generally two to five years, though the amortization periods extend over 25 to 35 years, compared with the 20 to 30 years seen in most jurisdictions. At maturity new loans are granted refinancing the maturing ones. The covered bonds have a weighted average residual maturity (WAM) of approximately 2.9 years compared to 3 years for the cover assets. Also, the level of AP supporting the 'AAA' rating is influenced by the high credit quality of assets insured by the CMHC. The AP supporting a given rating will be affected, among other things, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuances.
For this programme, the AP supporting a 'AAA' rating is matched by the programme's contractual AP of 93.5%. By comparison, the actual AP post-issuance is approximately 63.5%, corresponding to the ratio of outstanding covered bonds (worth about CAD1 billion) to the total cover pool outstanding amount (CAD1.6 billion). However, according to the programme's documentation, the contractual AP must remain between 97% and 90%. This means that excess collateral representing the difference in AP between 63.5% and the then current contractual, no higher than 90%, would not be available as protection to investors in an event of default of the issuer.
As of Nov. 30, 2010, the cover pool consisted of 13,824 first-lien, CMHC-insured residential mortgage loans, including 25.4% multi-tranche loans. Only conventional amortizing components within the multi-tranche product are allowed to be included in the cover pool, so Fitch applied its standard RMBS analysis applicable to Canadian mortgage loans. The outstanding principal balance of the aggregate pool is CAD1.6 billion and the average principal balance of the loans is CAD134,094. The portfolio has a weighted-average (WA) current loan-to-value (LTV) of 72.0%. The WA remaining term of the mortgages is 35 months and the WA seasoning is 16 months. The portfolio's largest geographic concentration is Quebec (78.9%).
Given the programme's dynamic nature, the composition and credit quality of the cover pool may change over time. In a 'AAA' scenario, Fitch has calculated a cumulative WA frequency of foreclosure (WAFF) for the cover assets of 33.0%, which includes an adjustment for the significant geographic concentration as compared to other Canadian cover pools and a WA recovery rate (WARR) of 96.5%, which reflects the benefit of the CMHC insurance on the loans. As limited performance data is available on the Canadian market, the agency's default analysis is based on the U.S. residential mortgage default model criteria with risk multipliers for Canadian provinces mapped to U.S. states with comparable economic characteristics and outlooks.
If CMHC lost the full backing of the Government of Canada, or if the Government of Canada suffered a downgrade, Fitch would revise the credit given to the CMHC insurance, which could lead to weaker liquidity and lower recovery expectations on the assets and subsequently a higher D-Factor and lower AP to support the rating.
Interest received from the cover assets will be swapped into CAD floating-rate plus a margin. As there is no requirement to maintain a higher margin, Fitch limits its credit given to the minimum payment applicable under the swap, which must be sized to be sufficient to cover the payments on the covered bonds plus a margin. In addition, the guarantor has entered into a swap to transform the Canadian dollar floating-rate cash flows into the USD-denominated fixed-rate flows payable on the bonds. For both the interest rate and covered bond swaps, NBC will serve as swap counterparty.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Relevant Research:
'Covered Bonds Rating Criteria', dated 13 Aug. 2010;
'Assessment of Liquidity Risks in Covered Bonds', dated 16 Aug. 2010;
'ResiLogic: U.S. Residential Mortgage Loss Model Criteria', dated 11 Aug., 2009;
'National Risk Index, State- and MSA-level Risk Multipliers in ResiLogic', dated 22 Dec., 2010;
'Counterparty Criteria for Structured Finance Transactions', dated 22 Oct., 2009;
'Counterparty Criteria for Structured Finance Transactions: Derivative Addendum', dated 23 Oct., 2009.
Applicable Criteria and Related Research:
Counterparty Criteria for Structured Finance Transactions: Derivative Addendum - Amended
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=475606
Assessment of Liquidity Risks in Covered Bonds
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=540786
Covered Bonds Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=547527
ResiLogic: U.S. Residential Mortgage Loss Model Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=461916
National Risk Index, State- and MSA-level Risk Multipliers in ResiLogic
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=589065
Counterparty Criteria for Structured Finance Transactions
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=475588
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