DBRS Confirms “A” Ratings on Novo Banco Conditional Pass-Through Covered Bonds Programme, Decouples Covered Bonds Attachment Point

DBRS Ratings Limited (DBRS) has today confirmed its “A” ratings on the four series of obrigações hipotecárias (OH, the Portuguese mortgage covered bonds) issued under Novo Banco, S.A. Conditional Pass-Through Covered Bonds Programme (NB PT OH or the Programme). The Programme was established in October 2015 under the Portuguese covered bond law to issue up to EUR 10 billion of OH. Novo Banco, S.A. issued OH for a total nominal amount of EUR 3.7 billion.

The confirmations follow the downgrade yesterday of the Long Term (LT) rating of the Issuer to CCC (high) from B and the decoupling of the Covered Bonds Attachment Point (CBAP) from the senior unsecured rating of the Issuer, as contemplated in the “Rating European Covered Bonds” methodology. The CBAP is confirmed at BB (low), currently four notches above the LT rating of the Issuer.

The downgrade of the LT rating of the Issuer reflects DBRS’s view that the Bank of Portugal’s decision to transfer some of the Issuer’s senior debt instruments to Banco Espirito Santo could have a further impact on investor sentiment and confidence in Novo Banco, as well as increasing reputational risk. DBRS considers this could negatively affect the Issuer’s senior debt and its probability of bearing losses. However, it is the opinion of DBRS that, due to the functions the Issuer fulfils in the Portuguese economy, there is a greater probability that the Covered Bonds will remain in a going concern entity. Consequently the CBAP remains unchanged.

The rating is based on the following analytical considerations:
-- A CBAP of BB (low). Novo Banco, S.A. (NB) is the Issuer and Reference Entity for the Programme.
-- A Legal and Structuring Framework (LSF) Assessment of Adequate associated with NB PT OH.
-- A Cover Pool Credit Assessment (CPCA) of A (high), being the lowest CPCA in line with the covered bonds rating.
-- A LSF-Implied Likelihood (LSF-L) of BBB (high).
-- A two-notch uplift for high recovery prospects.
-- A level of overcollateralisation (OC) of 8.9% that DBRS gives credit to, being the minimum observed OC level adjusted by a scaling factor of 0.9x.

The transaction was modelled using the DBRS European Covered Bond Cash Flow Model. The main assumptions focused on the timing of defaults and recoveries of the assets, interest rate stresses and senior costs. As a deviation from its “Rating European Covered Bonds” methodology, no forced assets liquidation has been modelled for this transaction given the conditional pass-through structure. Furthermore, DBRS has assumed several prepayment scenarios ranging between 0% and 10%.

Everything else being equal, a downgrade of the CBAP by one notch would lead to a downgrade of the LSF-L by two notches, resulting in a downgrade of the covered bonds rating by two notches. In addition, everything else being equal, the NB PT OH ratings would be downgraded if any of the following occurred: the sovereign of the Republic of Portugal were downgraded below the CBAP or the quality and consistency of the cover pool (CP) were no longer sufficient to support a two-notch uplift for high recovery prospects.

DBRS has assessed the LSF related to the NB PT OH as Adequate according to its rating methodology. The Adequate LSF assessment assigned to NB PT OH reflects DBRS’s view of: (1) the satisfactory level of segregation provided by the OH legal framework and the CB holders’ first priority right on the CP, in combination with possible residual commingling risk as addressed by DBRS; (2) the 50-year maturity extension provision that, in DBRS’s stressed simulations, allows all loans in the CP to amortise fully and related recoveries to be collected, hence making the structure a pass-through; (3) the lack of any regulatory requirement to cover temporary liquidity constraints, combined with a dynamic liquidity reserve that resets on each payment date prior to an Issuer event of default to a level sufficient to cover CB interests due during the subsequent three months plus EUR 100,000 as a partial coverage of other senior costs and expenses; (4) the role of the Bank of Portugal in the supervision of the Portuguese OH, combined with the high penetration of the OH as a funding tool for Portuguese banks in a BBB (low) Host Sovereign; and (5) the role of the asset monitor that only reports to the regulator indirectly. For more information on the OH legal framework, please refer to DBRS’s “Portuguese Covered Bonds: Legal and Structuring Framework Review” commentary available at www.dbrs.com.

The Issuer contractually funds the liquidity reserve account on a dynamic basis. The reserve account is currently held with Société Générale S.A. London Branch. Portuguese Covered Bonds law requires the funds to be deposited with the Bank of Portugal or a financial institution rated at least A (low) or equivalent. The cash reserve is part of the CP and is reported to the Bank of Portugal as available funds of the CP.

NB PT OH currently has EUR 3.7 billion of OH outstanding under the programme, while as at 7 October 2015 the CP was composed of EUR 50 million of Spanish Government bonds and EUR 4.014 billion of mortgages, resulting in a total OC of 9.8%. The level DBRS gives credit to is 8.9%, after applying a scaling factor of 0.90.

As at 7 October 2015, the cover pool outstanding balance was EUR 4.014 billion and is comprised of 82,477 residential mortgages with a weighted-average current unindexed loan-to-value ratio (LTV) of 55.5%, a weighted-average seasoning of 99 months and a weighted-average remaining time to maturity of 291 months. The pool is mainly distributed between Northern Portugal (28%), Lisbon area (38%) and Central Portugal (21%).

NB PT OH do not benefit from hedging agreements to cover the mismatch between the interest paid by the CP (98.7% floating rate linked to different indexes and reset dates) and the interest paid to the CB holders, linked to three-months Euribor plus 25 basis points with quarterly resets. If the maturity of the bonds is extended, the outstanding series become pass-through series paying one-month Euribor plus 25 basis points on a monthly basis. This risk is partly mitigated by the OC available and has been accounted for in DBRS’s cash flow model.

The weighted-average life of the assets is roughly 15 years, whereas the current weighted-average life of the OH is roughly four-and-a-half years, not accounting for any extension of maturity. All cover pool assets are denominated in euros, as well as all covered bonds. As such, investors are not currently exposed to any foreign exchange risk.

For further information on NB PT OH, please refer to the rating report available on www.dbrs.com.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable is “Rating European Covered Bonds” (December 2015). This can be found at http://www.dbrs.com/about/methodologies. Other methodologies and criteria referenced in this transaction are listed at the end of this press release. This is an event-driven rating action, and DBRS has not applied the principal methodology in full. A review of the transaction legal documents was not conducted as the documents have remained unchanged since the most recent rating action.

Other methodologies and criteria referenced in this transaction are listed at the end of this press release. This may be found on www.dbrs.com at http://www.dbrs.com/about/methodologies.

For a more detailed discussion of sovereign risk impact on Structured Finance ratings, please refer to DBRS’s “The Effect of Sovereign Risk on Securitisations in the Euro Area” commentary at http://www.dbrs.com/industries/bucket/id/10036/name/commentaries/.

The sources of information used for this rating include historical default performance data and CP loan-by-loan data tables provided by Novo Banco, S.A. that allowed DBRS to further assess the portfolio.

DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not rely upon third-party due diligence in order to conduct its analysis; DBRS was not supplied with third-party assessments. However, this did not impact the rating analysis.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

The last rating action on this transaction took place on 15 December 2015, when DBRS assigned the “A” rating of the OH.

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.

For further information on DBRS historic default rates published by the European Securities and Markets Administration in a central repository, see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Initial Lead Analyst: Covadonga Aybar
Initial Rating Date: 15 December 2015
Initial Rating Committee Chair: Quincy Tang

Lead Surveillance Analyst: Covadonga Aybar
Rating Committee Chair: Quincy Tang

DBRS Ratings Limited
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The rating methodologies and criteria used in the analysis of this transaction can be found at http://www.dbrs.com/about/methodologies.

-- Rating European Covered Bonds
-- Global Methodology for Rating Banks and Banking Organisations
-- DBRS Criteria: Support Assessments for Banks and Banking Organisations
-- Legal Criteria for European Structured Finance Transactions
-- Derivative Criteria for European Structured Finance Transactions
-- Unified Interest Rate Model for European Securitisations
-- Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda
-- Operational Risk Assessment for European Structured Finance Originators
-- Operational Risk Assessment for European Structured Finance Servicers
-- The Effect of Sovereign Risk on Securitisations in the Euro Area
-- Sovereign Ratings Provide a Benchmark for other DBRS Credit Ratings

A description of how DBRS methodologies are collectively applied can be found at http://www.dbrs.com/research/278375.