DBRS Assigns AAA Rating to National Bank of Canada Covered Bonds, Series 2, Tranche 2

DBRS Limited (DBRS) has today assigned a rating of AAA to the Series 2 (Tranche 2) covered bonds (the Covered Bonds) issued under the National Bank of Canada (NBC) USD 5 billion Global Public Sector Covered Bond Programme (the Programme). The USD 600 million Covered Bonds are a re-opening of the existing Series 2 (Tranche 1) covered bonds and have the same coupon rate (2.20%) and maturity date (October 19, 2016). As all covered bonds issued under the Programme rank pari passu with each other, DBRS has also confirmed the AAA ratings of all other outstanding series.

The rating is based on several factors:

(1) 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.

(2) 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 $3.0 billion as of December 31, 2011, and was subsequently increased to an amount sufficient for the issuance of the Covered Bonds.

(3) The Covered Bonds benefit from several structural features, such as a reserve fund, when applicable, and rating thresholds for the swap counterparties, servicer and cash manager.

(4) Upon a default by NBC, 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:

(1) 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 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.

(2) 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 latest review of the Cover Pool, DBRS considers 3.1% overcollateralization (corresponding to an asset percentage of 97%) as the amount commensurate with a AAA rating. In comparison, at least 7.3% overcollateralization was available for the Covered Bonds, which is based on the asset percentage of 93.2% as of December 31, 2011.

(3) 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 is not rated at least A (low) and R-1 (middle) and the 12-month maturity extension upon a default by NBC.

(4) 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 $156.3 billion and $6.6 billion in common equity as at October 31, 2011. 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 Rating Canadian Covered Bonds, which can be found on our website under Methodologies.

The sources of information used for this rating include loan-level data provided by NBC. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating concerns a newly issued financial instrument.

This is the first DBRS rating on this financial instrument.

For additional information on this rating, please see the Canadian Covered Bonds Linking Document.

Lead Analyst: Kevin Chiang
Rating Committee Chair: Jamie Feehely
Initial Rating Date: February 10, 2012
Most Recent Rating Update: February 10, 2012

This credit rating has been issued outside the European Union (EU) and may be used for regulatory purposes by financial institutions in the EU.

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 under Related Research at the right of the screen or by contacting us at info@dbrs.com.