DBRS Assigns Provisional Rating of AAA to National Bank of Canada Covered Bonds, Series 1

DBRS has today assigned a provisional rating of AAA to the Covered Bonds, Series 1 (the Covered Bonds) to be issued under the National Bank of Canada (NBC) US$5 billion Global Public Sector Covered Bond Programme (the Programme).

The finalization of the rating is contingent upon receipt of final documents conforming to information already received.

The rating is based on several factors. First, the Covered Bonds are senior unsecured direct deposit obligations of NBC, which is the sixth largest bank in Canada by assets, rated AA (low) and R-1 (middle) with Stable trends by DBRS. Second, in addition to a general recourse to NBC’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 $1.565 billion as of November 30, 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 NBC, the final maturity date on the Covered Bonds can be extended for 12 months or if hard-bullet Covered Bonds are issued, the funding of pre-maturity liquidity is required, 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, the Cover Pool has a large concentration in Québec, exposing the Cover Pool assets to high geographic and regional economic risk. A weakened housing market in Québec 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, NBC 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 rating assigned. Based on the Cover Pool as of November 30, 2010, DBRS considers 3% overcollateralization (corresponding to an asset percentage of 97%) as the minimum required for a AAA rating. Third, there is an inherent liquidity gap between the scheduled repayments of the Covered Bonds and the repayment of underlying mortgage loans over time. This risk is mitigated by the overcollateralized Cover Pool, the buildup of a reserve fund if NBC fails to maintain a rating of either A (low) or R-1 (middle) and, upon a default by NBC, the extendible maturity date for 12 months or funding of pre-maturity liquidity for hard-bullet Covered Bonds. 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 NBC and a generally creditor-friendly legal environment in Canada.

NBC is Canada’s sixth largest bank, with assets of $145.3 billion and $6.1 billion in common equity as at October 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.