DBRS Assigns Provisional Rating of AAA to NBC Legislative Covered Bonds, Series CBL1

DBRS Limited (DBRS) has today assigned a provisional rating of AAA to the Series CBL1 covered bonds (the Covered Bonds) to be issued under the National Bank of Canada (NBC) Legislative Global Covered Bond Programme (the Legislative Programme). The Legislative Programme is established after the enactment of the covered bond legislation in Canada and the guide issued by the Canada Mortgage and Housing Corporation. All covered bonds issued and to be issued under the Legislative Programme rank pari passu with each other.

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

The AAA 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 and 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 pool of first-lien, conventional Canadian residential mortgages with a maximum loan-to-value (LTV) of 80% at origination (the Cover Pool). The Cover Pool was approximately $5.5 billion as of June 30, 2013. The mortgages may have amortizing and non-amortizing, revolving loan parts secured by the same first lien. Only the amortizing loan parts are in the Cover Pool.

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

(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.

(5) There is a specific covered bond legislative framework in Canada. In addition, the contractual obligations of the transaction parties are supported by Canada’s well-developed commercial and bankruptcy laws, the satisfactory opinions provided by legal counsel to NBC and a generally creditor-friendly legal environment in Canada.

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 to high geographic and regional economic risk. A weakened housing market in Canada, especially in Québec, could result in higher defaults and/or lower recoveries than the assumptions used for credit loss assessment. This risk is significantly reduced by the home equity available in relation to the portfolio weighted-average LTV of 59.8% as of June 30, 2013.

(2) NBC may need to add mortgages to maintain the Cover Pool, incurring substitution and potential credit deterioration risk. These risks are mitigated by the ongoing monitoring of the Cover Pool to ensure the overcollateralization (OC) available is commensurate with the AAA rating of the Covered Bonds. Based on the latest review of the Cover Pool and the application of DBRS’s market value spread (see DBRS press release dated June 13, 2013), DBRS considers 8.7% OC (corresponding to an asset percentage of 92.0%) sufficient for a AAA rating. In comparison, at least 9.1% OC was available for the Covered Bonds, based on the asset percentage of 91.7% as of December 9, 2013.

(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 OC, the buildup of a reserve fund if NBC is not rated at least A (low) or R-1 (middle) and the 12-month maturity extension upon default by NBC.

DBRS notes that the rating threshold of A (high) or R-1 (middle) for account bank is lower than the AA (low) or R-1 (middle) threshold in DBRS's legal criteria. In addition, DBRS's legal criteria expects regular swap payments to rank no higher in priority than interest payments on the Covered Bonds. Should the account bank fail to maintain a rating of AA (low) or R-1 (middle), or interest rate swap payments (excluding termination payments) rank higher in priority than interest payments on the Covered Bonds, DBRS will assess the impact at that time and take the appropriate rating action.

NBC is Canada’s sixth largest bank as measured by assets, with assets of $187.2 billion and $7.1 billion in common equity as at July 31, 2013. It is the servicer of the mortgages in the Cover Pool.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The principal methodology applicable is Rating Canadian Covered Bonds, which can be found on www.dbrs.com.

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

More details on the Cover Pool and the Legislative Programme are provided in the Monthly Canadian Covered Bond Report, which is available by clicking on the link under Related Research or by contacting us at info@dbrs.com.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.