DBRS Morningstar Assigns AAA Rating to RBC Covered Bonds, Series CB48

DBRS Limited (DBRS Morningstar) assigned a rating of AAA to the Covered Bonds, Series CB48 (Series CB48) issued under the Royal Bank of Canada (RBC) Global Covered Bond Programme (the Programme). Series CB48 (EUR 120 million) has a coupon rate of 0.667% and a maturity date of January 24, 2040. All covered bonds issued under the Programme (the Covered Bonds) rank pari passu with each other and are currently rated AAA by DBRS Morningstar.

The AAA ratings are based on the following analytical considerations:

-- A Covered Bond Attachment Point of AA (high), which is the DBRS Morningstar Long-Term Senior Debt rating of RBC. RBC is the Reference Entity for the Programme.
-- A Legal and Structuring Framework (LSF) assessment of Strong associated with the Programme.
-- A Cover Pool Credit Assessment of “A.”
-- An LSF-Implied Likelihood (LSF-L) of AAA.
-- While not currently applicable, based on the recovery notching scale, up to two notches’ uplift from the LSF-L for high recovery prospects is possible.
-- A level of overcollateralization (OC) of 7.5% (based on the Asset Percentage of 93.0% as at December 31, 2019) to which DBRS Morningstar gives credit.

DBRS Morningstar considered the following factors in its analysis described above:

(1) The Covered Bonds are senior unsecured direct-deposit obligations of RBC and are excluded from Canada’s bank recapitalization (bail-in) regime.

(2) In addition to a general recourse to RBC’s assets, the Covered Bonds are supported by a diversified collateral pool of first-lien conventional residential mortgages with maximum loan-to-value (LTV) ratios of 80.0% at origination in Canada (the Cover Pool). The Cover Pool of approximately $51.8 billion as of December 31, 2019, has experienced low credit losses historically. 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, and cash manager.

(4) Upon a default by RBC, 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 RBC, and a generally creditor-friendly legal environment in Canada.

Despite these strengths, the ratings could face the following challenges:

(1) A weakened housing market in Canada could result in higher defaults and/or lower recoveries than the assumptions used in the Cover Pool’s credit assessment. This risk is significantly reduced by the home equity available in relation to the portfolio’s weighted-average LTV of 48.2% (based on indexed property value) reported by RBC as of December 31, 2019.

(2) RBC 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 that the OC available is commensurate with the ratings of the Covered Bonds. Based on the latest review of the Cover Pool, DBRS Morningstar considers 3.0% OC, corresponding to the Regulatory OC Minimum, commensurate with the AAA ratings.

(3) There is an inherent liquidity gap between the scheduled payments of the Covered Bonds and the repayment of the underlying mortgage loans over time. This risk is mitigated by the OC, the buildup of a reserve fund if RBC is not rated at least A (low) or R-1 (middle), and the 12-month maturity extension upon default by RBC.

DBRS Morningstar notes that there is no cap on indemnity amounts payable to service providers in the payment waterfalls following issuer default or acceleration of the Covered Bond payments as expected in DBRS Morningstar’s “Legal Criteria for Canadian Structured Finance” methodology. If the indemnity is above a reasonable amount, DBRS Morningstar will assess the impact of uncapped cash outflow at the time and take appropriate rating action. In addition, DBRS Morningstar’s “Legal Criteria for Canadian Structured Finance” methodology indicates that DBRS Morningstar expects to be an addressee of all legal opinions; however, DBRS Morningstar will not be an addressee of a foreign legal opinion in this case.

RBC is one of Canada’s largest banks as measured by assets with $1,428.9 billion in assets and common equity of $77.8 billion as of October 31, 2019. RBC is also the servicer of the mortgages in the Cover Pool.

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

The principal methodology is Rating and Monitoring Covered Bonds (June 2019), which can be found on dbrs.com under Methodologies & Criteria.

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 under Related Documents or by contacting us at info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process.

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 Documents or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on the Programme took place on January 21, 2020, when DBRS Morningstar assigned a AAA rating to the Covered Bonds, Series CB47.

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

Lead Analyst: Fanfei Gong, Assistant Vice President, CDN ABS and Pension Funds
Rating Committee Chair: Tim O’Neil, Managing Director, Head of Canadian Structured Finance
Initial Rating Date: October 8, 2007

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

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