DBRS Morningstar Confirms NBC Legislative Global Covered Bonds, Series CBL7 at AAA Post-Reopening

DBRS Limited (DBRS Morningstar) confirmed the rating of AAA on the Covered Bonds, Series CBL7 (Series CBL7) issued under the National Bank of Canada (NBC) Legislative Global Covered Bond Programme (the Programme) following the reopening of Series CBL7. NBC reopened the Series CBL7 covered bonds by issuing an additional EUR 250 million with the same coupon rate (0.75%) and maturity date (March 13, 2025) as the initial issuance. The total amount of the Series CBL7 covered bonds outstanding after the reopening is EUR 1 billion. 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 (low), which is the DBRS Morningstar Long-Term Senior Debt rating of NBC. NBC is the Reference Entity for the Programme.
-- A Legal and Structuring Framework (LSF) assessment of Strong is associated with the Programme.
-- A Cover Pool Credit Assessment of A (high).
-- An LSF-Implied Likelihood (LSF-L) of AA (high).
-- A one-notch uplift from the LSF-L for high recovery prospects to achieve the AAA ratings. Based on the recovery notching scale, an uplift of up to two notches from the LSF-L is possible.
-- A level of overcollateralization (OC) of 9.1% (based on the Asset Percentage of 91.7% as at December 31, 2021) 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 NBC and are excluded from Canada’s bank recapitalization regime.

(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 80.0% at origination (the Cover Pool). The Cover Pool was approximately $14.9 billion as of December 31, 2021. The mortgages may have amortizing and nonamortizing 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 these strengths, the ratings on the Covered Bonds could face the following challenges:

(1) The Cover Pool has a large concentration in the Province of Québec, exposing the Cover Pool to high geographic and regional economic risks. A weakened housing market in Canada, especially in Québec, could result in higher defaults and/or lower recoveries than the assumptions used in the Cover Pool Credit Assessment. This risk is significantly reduced by the home equity available in relation to the portfolio weighted-average LTV of 42.3% (based on indexed property value) reported by NBC as of December 31, 2021.

(2) NBC may need to add mortgages to maintain the Cover Pool, incurring substitution and potential credit deterioration risks. 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 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 (low), and the 12-month maturity extension upon default by NBC.

DBRS Morningstar's “Derivatives Criteria for Canadian Structured Finance” expects regular swap payments to rank no higher in priority than interest payments on the Covered Bonds. Should interest rate swap payments (excluding termination payments) rank higher in priority than interest payments on the Covered Bonds, DBRS Morningstar 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 $355.8 billion in assets and $16.2 billion in common equity as of October 31, 2021. NBC is the servicer of the mortgages in the Cover Pool.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodology is Rating and Monitoring Covered Bonds (June 10, 2021), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482/baseline-macroeconomic-scenarios-application-to-credit-ratings.

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@dbrsmorningstar.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@dbrsmorningstar.com.

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

The last rating action on this Programme took place on January 27, 2022, when DBRS Morningstar assigned a AAA rating to the Covered Bonds, Series CBL17.

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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

Lead Analyst: Geetika Gupta, Vice President, Canadian Structured Finance
Rating Committee Chair: Tim O'Neil, Managing Director, Head of Canadian Structured Finance
Initial Rating Date: December 9, 2013

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

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

Principal methodology: Rating and Monitoring Covered Bonds (June 10, 2021)
Link: https://www.dbrsmorningstar.com/research/379983/rating-and-monitoring-covered-bonds

Predictive model: Canadian RMBS Model (November 2021; Version 5.0.0.3)
Link: https://www.dbrsmorningstar.com/models/