DBRS Assigns AAA Ratings to Bank of Nova Scotia Covered Bonds, Series 1 and Series 2

DBRS has today finalized the rating of AAA for the Covered Bonds, Series 2 issued under the Bank of Nova Scotia (BNS) US$15 billion Global Public Sector Covered Bond Programme (the Programme). The Series 2 (US$2.5 billion) covered bonds have a coupon of 1.65% and a maturity date of October 29, 2015. As all covered bonds issued under the Programme (the Covered Bonds) rank pari passu with each other, DBRS has also today assigned a rating of AAA to the Covered Bonds, Series 1 issued on July 26, 2010, under the Programme. The Series 1 (US$2.5 billion) covered bonds have a coupon of 1.45% and a maturity date of July 26, 2013.

The AAA ratings are based on several factors. First, the Covered Bonds are senior unsecured direct deposit obligations of BNS, which is the third largest bank in Canada and rated AA and R-1 (high) with a Stable trend by DBRS. Second, in addition to a general recourse to BNS’s assets, the Covered Bonds are supported by a diversified collateral pool (the Cover Pool) of first-lien prime residential mortgages insured by Canada Mortgage and Housing Corporation (CMHC). CMHC is an agent of Her Majesty in right of Canada and is rated AAA by DBRS. The Cover Pool was approximately $7.45 billion as of October 1, 2010. Third, the Covered Bonds benefit from several structural features, such as a reserve fund, when applicable, and a minimum rating requirement for the swap counterparties and servicer. And, lastly, upon a default by BNS, the final maturity date on the Covered Bonds can be extended for 12 months, which increases the likelihood that the Covered Bonds can be fully repaid.

Despite the above strengths, the Covered Bonds could face the following challenges. First, a weakened housing market in Canada could result in higher defaults and lower recoveries than the assumptions used for credit protection assessment. This risk is significantly mitigated by the mortgage insurance covering principal and interest provided by AAA-rated CMHC. Second, BNS may be required to add mortgages to maintain the Cover Pool, incurring substitution and potential credit deterioration risk. These risks are mitigated by the mortgage insurance provided by CMHC and the ongoing monitoring of the Cover Pool to ensure the overcollateralization available is commensurate with the AAA ratings assigned. Based on the Cover Pool as of October 1, 2010, DBRS considers 3% overcollateralization as the minimum amount required for a AAA rating, versus 5% available as of September 30, 2010. Third, there is an inherent liquidity gap between the scheduled repayments of the Covered Bonds and the repayment of the underlying mortgage loans over time. This risk is mitigated by the overcollateralized Cover Pool, the buildup of a reserve fund if BNS’s rating falls below A (low) or R-1 (middle) and the extendible maturity date for 12 months upon a default by BNS. Lastly, there is no specific covered bond legislative framework in Canada. This risk is mitigated by the contractual obligations of the transaction parties, supported by the well-developed commercial and bankruptcy laws in Canada, satisfactory opinions provided by legal counsel to BNS and a generally creditor-friendly legal environment in Canada.

BNS is Canada’s third largest bank, with assets of $523.4 billion and $22.5 billion in common equity as at July 31, 2010. It is the servicer of the mortgages in the Cover Pool.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Covered Bonds: DBRS’s Rating Approach (to Canadian Issues), which can be found on our website under Methodologies.