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Bank of Montreal : Fitch Affirms Five Canadian Registered Mortgage Covered Bond Programs at 'AAA'

April 05, 2021 at 04:20 am EDT

Fitch Ratings has affirmed the ratings of the legislative mortgage covered bonds issued by Bank of Montreal (BMO; AA-/F1+/Negative), The Bank of Nova Scotia (BNS; AA-/F1+/Negative), Canadian Imperial Bank of Commerce (CIBC; AA-/F1+/Negative), National Bank of Canada (A+/F1/Stable) and Royal Bank of Canada (RBC; AA/F1+/Negative) at 'AAA'/Outlook Stable.

This follows Fitch's annual review of these covered bond programs.

KEY RATING DRIVERS

The covered bonds' 'AAA' ratings are based on BMO, BNS, CIBC, NBC and RBC's Issuer Default Rating (IDR), the various uplifts above the IDR granted to the programs and the overcollateralization (OC) protection provided through the programs' asset percentage (AP).

The RBC covered bonds are rated two notches above its IDR, the BMO, BNS, and CIBC covered bonds are rated three notches above their IDRs, and the NBC covered bonds are rated four notches above its IDR. This is out of a maximum achievable uplift of 10 notches, consisting of an Resolution uplift of two notches, a payment continuity uplift (PCU) of six notches and a recovery uplift of two notches.

Fitch relies on the committed AP used in the Asset Coverage Test and as reported in the covered bond investor reports. The February 2021 investor reports state an AP of 94.8% for BNS', 93.5% for BMO's, 93.0% for RBC's and CIBC's, and 91.7% for NBC's programs, which provide more protection than Fitch's 'AAA' breakeven AP of 100% for BNS', BMO's, CIBC's, and RBC's covered bonds and of 92.5% for NBC's covered bonds.

The Stable Outlooks reflect a seven-notch buffer against an IDR downgrade for BNS', BMO's, and CIBC's covered bonds; an eight -notch buffer against an IDR downgrade for RBC's covered bonds, and a six-notch buffer against an IDR downgrade for NBC's covered bonds.

Uplifts

The two-notch Resolution uplift reflects that the covered bonds of BNS, BMO, CIBC, NBC and RBC are exempt from bail-in, which Fitch deems the risk of under-collateralization at the point of resolution to be sufficiently low, and that a resolution of these banks, should it happen, is not likely to result in the direct enforcement of the recourse against the cover pool.

The six-notch PCU reflects the principal liquidity protection provided by the 12-month maturity extension, as well as a dynamic reserve that will cover three months of senior expenses and interest payments. The reserve will be funded when the issuer's Long-Term IDR is rated below 'A' or the issuer's Short-Term IDR is rated below 'F1'.

The recovery uplift for these programs is two notches, as the program's tested rating on a probability of default (PD) basis is in the investment-grade range and no material downside risk to recoveries have been identified. Fitch deems that the foreign exchange risk in a recovery given default scenario is mitigated by the shorter weighted average life of the assets compared with the liabilities.

OC Protection

Fitch's 'AAA' breakeven AP is 100% for BNS', BMO's and CIBC's covered bonds. This supports a one-notch recovery uplift above the 'AA+' tested rating on a PD basis, represented by BNS', BMO's and CIBC's Long-Term IDR of 'AA-', adjusted by the program's two-notch Resolution uplift. Under Fitch's criteria, fully collateralized programs secured by standard assets, such as mortgage loans, are eligible for a one-notch recovery uplift.

Fitch's 'AAA' breakeven AP is also 100% for RBC's covered bonds, as they reach 'AAA' on a PD basis based on RBC's Long-Term IDR of 'AA' adjusted by the program's two-notch Resolution uplift.

Fitch's 'AAA' breakeven AP for NBC's covered bonds is 92.5%. This supports timely payments in a stress scenario equivalent to 'AA+' and allows for a one-notch recovery uplift to 'AAA'.

Fitch relied on prior asset model output in the cash flow analysis that was used to determine the breakeven AP for the rating of NBC's covered bonds. This is because the collateral is comprised of residential mortgages only, the OC buffer between the relied upon and the breakeven level for the rating is above 25% and the weighted average combined loan-to-value (CLTV) has not increased by more than 5% since the last model run, among other conditions.

For all the Canadian covered bond programs, Fitch disregards the part of the available OC between the cover pool and the covered bonds that is owed by the covered bond guarantor to the issuer in the form of a demand loan. This is because it ranks senior to covered bondholders, should recourse against the cover pool be enforced.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

The BNS, BMO, CIBC, NBC, and RBC covered bonds ratings are 'AAA', which is the highest level on Fitch's scale. The ratings cannot be upgraded.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

For RBC, the 'AAA' covered bonds rating would be vulnerable to a downgrade if the Long-Term IDR were downgraded by nine or more notches to 'BB' or below;

BMO's, BNS', and CIBC's 'AAA' covered bonds' rating would be vulnerable to a downgrade if the bank's IDR was downgraded by eight or more notches to 'BB' or below.

For NBC, the 'AAA' covered bonds rating would be vulnerable to a downgrade if the bank's Long-Term IDR were downgraded by seven or more notches to 'BB' or below.

Fitch's 'AAA' breakeven AP would decrease in the event of an IDR downgrade. Should RBC, BMO, BNS, or CIBC be downgraded to 'A+', the 'AAA' breakeven AP would correspond to the OC offsetting the cover pool's credit loss in a 'AAA' stress scenario.

In addition, the covered bonds would be vulnerable to a downgrade if the relied upon AP provided less protection than Fitch's 'AAA' breakeven AP.

Fitch expects the coronavirus containment measures to negatively affect the performance of Canadian residential mortgage loans. However, the covered bond ratings benefit from a significant cushion between the AP, which Fitch relies upon in its analysis and Fitch's 'AAA' breakeven AP. In addition, the ratings are well-protected by the six to eight-notch buffer against a downgrade of the issuers IDR. Nevertheless, the agency expects the AP cushion and the buffer against an issuer downgrade to reduce as a consequence of the coronavirus crisis.

Downside Scenario Stress Sensitivity

Fitch used the coronavirus pandemic as a proxy for a downside scenario sensitivity. To account for declining macroeconomic conditions resulting from the coronavirus, Fitch increased the expected loss for the 'B' and 'BB' ratings in the downside scenario stress sensitivity. The 'AA' and 'AAA' assumptions remain unchanged in the downside scenario stress sensitivity, since Fitch deems them sufficiently remote. Also, the agency expects the declining macroeconomic conditions resulting from coronavirus to be a short-term disruption that reflects a 'B' and 'BB' rating stress based on the GDP decline that Fitch is forecasting following the coronavirus related containment efforts.

Fitch's breakeven AP for the covered bond rating will be affected, among other factors, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuance. Therefore, the breakeven AP to maintain the covered bond rating cannot be assumed to remain stable over time.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579]

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS

The covered bond ratings are driven by the credit risk of the issuer's parent bank as measured by its Long-term IDR.

RATING ACTIONSENTITY/DEBT	RATING		PRIOR

Canadian Imperial Bank of Commerce (CIBC)