DBRS Finalizes AAA Rating on Bank of Nova Scotia Covered Bonds, Series 3

DBRS has today finalized the AAA rating on the Covered Bonds, Series 3 issued under the Bank of Nova Scotia (BNS) Global Public Sector Covered Bond Programme (the Programme). The Series 3 (AUD 1.0 billion) covered bonds have a coupon rate of 5.75% and a hard-bullet maturity date of January 28, 2014. All covered bonds issued under the Programme (the Covered Bonds) rank pari passu with each other and are currently rated AAA with Stable trends by DBRS.

The 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 by assets, rated AA and R-1 (high) with Stable trends by DBRS. Second, in addition to a general recourse to BNS’s assets, the Covered Bonds are supported by a diversified collateral pool of first-lien, prime residential mortgages insured by Canada Mortgage and Housing Corporation (CMHC) (the Cover Pool). CMHC is an Agent of Her Majesty in Right of Canada and is rated AAA by DBRS. The Cover Pool was approximately $7.06 billion as of December 31, 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, servicer and cash manager. And, lastly, the final maturity date on the non hard-bullet Covered Bonds can be extended for 12 months upon a default by BNS, or, for hard-bullet Covered Bonds, the funding of pre-maturity liquidity is required if BNS’s rating falls below certain thresholds, 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 as DBRS considers the credit loss negligible for defaulted mortgages as a result of 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 that the overcollateralization available is commensurate with the AAA rating assigned. Based on the latest review of the Cover Pool as of October 1, 2010, DBRS considers 3% overcollateralization (corresponding to an asset percentage of 97%) as the minimum required for a AAA rating, compared with at least 5% overcollateralization available as of December 31, 2010. 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 BNS fails to maintain a rating of either A (low) or R-1 (middle) and, upon a default by BNS, the 12-month extendible maturity date for non hard-bullet Covered Bonds or funding of pre-maturity liquidity for hard-bullet Covered Bonds if BNS’s rating falls below certain thresholds. 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 had assets of $526.7 billion and $23.7 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.

There is no rating report for this issuance. More details on the Cover Pool and the Programme are provided in the Monthly Canadian Covered Bond Report which is available by clicking on the link below or by contacting us at info@dbrs.com.