OREANDA-NEWS. Fitch Ratings has affirmed the 'AAA' rating with a Stable Outlook on the National Bank of Canada's (NBC; 'A+'/'F1'; Outlook Stable) legislative mortgage covered bonds following Fitch's annual review.

KEY RATING DRIVERS
NBC's LEGISLATIVE MORTGAGE COVERED BONDS: The 'AAA' rating of NBC's legislative mortgage covered bonds is based on the issuer's Issuer Default Rating (IDR) of 'A+', Fitch's unchanged Discontinuity Cap (D-Cap) of 3 (moderate high risk), which allows for a maximum achievable rating on the covered bonds of 'AAA' on a probability of default (PD) basis. The rating is also based on the program's contractual asset percentage (AP) of 91.7% that Fitch takes into account in its analysis which provides more protection than the 93.0% 'AAA' breakeven AP.

The 93.0% 'AAA' breakeven AP, corresponding to a breakeven overcollateralization (OC) of 7.5% is driven by the cover pool's credit loss component of 8.4%, followed by the asset disposal loss of 3.4%. The cash flow valuation component leads to a lower 'AAA' breakeven OC by 1.4%. The 8.4% 'AAA' credit loss represents the impact on the breakeven OC from the 19.69% weighted average (WA) default rate and the 60.63% WA average recovery rate for the mortgage cover assets. The breakeven AP considers whether timely payments are met in an 'AA' scenario and tests for recoveries given default of at least 91% in an 'AAA' scenario, this is why the sum of the breakeven OC drivers is higher than NBC's 'AAA' breakeven OC.

Under the current Canadian banking legislation bail-in is not an explicit provision; therefore, in Fitch's view, the IDR remains a satisfactory indicator of the likelihood that the recourse against the cover pool would be enforced, and no IDR uplift is applicable.

Canadian covered bond program documents include a feature called the Selected Assets Required Amount (SARA) clause, which places some conditions on the sale of assets in the event of an issuer default. Fitch has considered the impact of this clause by modelling an issuer default in each of the first six quarters and in every quarter with a covered bond maturity date to ensure that OC would be sufficient for all possible sale periods under a given rating scenario.

There may be some scenarios not considered in Fitch's current analysis of the SARA clause in Canadian covered bond programs. Fitch is currently in the process of fine-tuning its approach to the SARA clause. Following this review, expected to be completed in the first quarter of 2016, Fitch will re-run the cash flow modelling on these programs to evaluate any impact on the break-even AP for the ratings.

RATING SENSITIVITIES

The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) NBC's IDR is downgraded by two or more notches to 'A-' or below; or (ii) the number of notches represented by the D-Cap is reduced to 1; or (iii) the AP that Fitch considers in its analysis increases above Fitch's 'AAA' breakeven level of 93.0%.

The Fitch breakeven AP for the covered bond rating will be affected, amongst 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.