DBRS Morningstar Assigns AAA Rating to Bank of Nova Scotia Registered Covered Bonds, Series CBL25

DBRS Limited (DBRS Morningstar) assigned a rating of AAA to the Covered Bonds, Series CBL25 (Series CBL25) issued under the Bank of Nova Scotia (BNS) Global Registered Covered Bond Program (the Registered Program). Series CBL25 (EUR 1.5 billion) has a coupon rate of 0.01% and a maturity date of January 14, 2027. All covered bonds issued under the Registered Program (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, which is the Long-Term Senior Debt rating of BNS. BNS is the Reference Entity for the Registered Program.
-- A Legal and Structuring Framework (LSF) assessment of Strong associated with the Registered Program.
-- A Cover Pool Credit Assessment of BBB (high).
-- An LSF-Implied Likelihood (LSF-L) of AA.
-- A two-notch uplift from the LSF-L for high recovery prospects to achieve the AAA ratings.
-- A level of overcollateralization (OC) of 5.5% (based on the Asset Percentage of 94.8% as of November 30, 2019) to which DBRS Morningstar gives credit.

The following factors were considered in the analysis described above:

(1) The Covered Bonds are senior unsecured direct-deposit obligations of BNS and are excluded from Canada’s bank recapitalization (bail-in) regime.
(2) In addition to a general recourse to BNS’ assets, the Covered Bonds are supported by a diversified pool of first-lien conventional Canadian residential mortgages with a maximum loan-to-value ratio (LTV) of 80.0% at origination (the Cover Pool). The Cover Pool was approximately $40.1 billion as of November 30, 2019. 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 guaranteed deposit account provider.
(4) Upon a default by BNS, 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 BNS, and a generally creditor-friendly legal environment in Canada.

Despite these strengths, the ratings on the Covered Bonds 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 52.3% (based on indexed property value) reported by BNS as of November 30, 2019.
(2) BNS 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, to be commensurate with the AAA ratings.
(3) There is an inherent liquidity gap between the scheduled repayments of the Covered Bonds and the repayment of the underlying mortgage loans over time. This risk is mitigated by OC, the buildup of a reserve fund if BNS is not rated at least A (low) or R-1 (middle), and the 12-month maturity extension upon default by BNS.

DBRS Morningstar’s “Legal Criteria for Canadian Structured Finance” methodology 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 appropriate rating action.

BNS is one of Canada’s largest banks as measured by assets as of October 31, 2019, with assets of $1,086.2 billion and total equity of $63.6 billion. It is the initial 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 Registered Program 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 Registered Program took place on September 11, 2019, when DBRS Morningstar discontinued the rating of Covered Bonds, Series CBL2, as the series was fully repaid.

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: Paul Bretzlaff, Senior Vice President
Rating Committee Chair: Tim O'Neil, Managing Director
Initial Rating Date: March 25, 2014

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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