DBRS Morningstar Confirms Novo Banco S.A. Covered Bonds (Obrigações Hipotecárias - Mortgages - CPT) Ratings at “A”

DBRS Ratings GmbH (DBRS Morningstar) confirmed its “A” ratings on the Obrigações Hipotecárias (OH; the Portuguese legislative Covered Bonds) issued under the Novo Banco S.A. (Novo Banco or the Issuer) Conditional Pass-Through Covered Bond Programme (the Programme). The confirmations follow the completion of a full review of the Programme.

There are seven series of OH outstanding under the Programme totalling a nominal amount of EUR 5.50 billion.

The ratings are based on the following analytical considerations:
-- A Covered Bonds Attachment Point (CBAP) of BB (high), which is the Long-Term Critical Obligations Rating of Novo Banco. Novo Banco is the Reference Entity (RE) for the Programme. DBRS Morningstar does not consider OH to be a systemically important financing tool in Portugal; however, DBRS Morningstar considers the assets in the Programme are strategic to the core activity of the RE.
-- A Legal and Structuring Framework (LSF) Assessment of “Adequate” associated with the Programme.
-- A Cover Pool Credit Assessment (CPCA) of BBB (high), which is the lowest CPCA in line with the LSF-Implied Likelihood (LSF-L).
-- An LSF-L of BBB (high).
-- A two-notch uplift for high recovery prospects.
-- The level of overcollateralisation (OC) of 9.0% to which DBRS Morningstar gives credit, which is the minimum level observed in the last 12 months adjusted by a scaling factor of 0.9.

DBRS Morningstar analysed the transaction using its European Covered Bond Cash Flow tool. The main assumptions focused on the timing of defaults and recoveries of the assets, and interest rate stresses.

Everything else being equal, a downgrade of the CBAP by one notch would lead to a downgrade of the LSF-L by one notch, resulting in a downgrade of the covered bonds (CBs) ratings by one-notch.

In addition, all else unchanged, the OH ratings would be downgraded if any of the following occurred: (1) the CPCA was downgraded below BBB (high); (2) the LSF Assessment associated with the Programme was downgraded; or (3) the quality of the cover pool (CP) and the level of OC were no longer sufficient to support a two-notch uplift for high recovery prospects.

As of 30 September 2020, the aggregated outstanding balance of the CP underlying the Issuer’s OH was EUR 6.05 billion. The total amount of liabilities outstanding is EUR 5.50 billion, yielding a current nominal OC ratio of 10.0%.

The majority (99.97%) of the loans in the CP are prime residential mortgage loans, the rest being the cash reserve. As at September 2020, the mortgage CP assets comprised 119,694 residential mortgage loans, with a weighted-average (WA) current unindexed loan-to-value ratio of 55.8%, a WA seasoning of 94 months and a WA remaining time to maturity of 303 months. The CP is located mainly in Lisbon (45.5% by outstanding balance), Northern Portugal (25.8%), and Central Portugal (17.1%).

Novo Banco’s OH do not benefit from hedging agreements to cover the mismatch between the interest paid by the CP (92% floating rate linked to different indexes and reset dates) and the interest paid to the CB holders, linked to three-month Euribor plus 25 basis points with quarterly resets. If the maturity of the bonds is extended, the outstanding series become pass-through paying one-month Euribor plus 25 basis points on a monthly basis. This risk is mitigated by the OC available and has been accounted for in DBRS Morningstar’s cash flow analysis.

The DBRS Morningstar-calculated WA life of the mortgage assets is roughly 14 years based on a 0% prepayment rate, which is longer than the 3.4 years of WA life on the OH, not accounting for any maturity extension. This risk is mitigated by the conditional pass-through nature of the OH.

All CP assets and OH are denominated in euros. As such, investors are not currently exposed to any foreign-exchange risk.

DBRS Morningstar has assessed the LSF related to the Programme as “Adequate” according to its rating methodology. For more information, please refer to DBRS Morningstar’s commentaries “DBRS Assigns LSF Assessment to Portuguese Covered Bonds” and “Portuguese Covered Bonds: Legal and Structuring Framework Review,” both available at www.dbrsmorningstar.com.

For further information on the Programme, please refer to the rating report at www.dbrsmorningstar.com.

On 25 November 2020, the Portuguese parliament approved a proposal that prevents the Resolution Fund from transferring funds to banks and other financial institutions. This includes funds that were to be transferred to Novo Banco as part of the existing Capital Contingency Agreement. This news was unexpected, and poses challenges for Novo Banco as it creates uncertainty for the bank’s capital and ongoing de-risking plan, as well as increasing the potential for litigation. For more information please see DBRS Morningstar’s commentary, “Political Impasse in Portugal Renews Risks for Novo Banco,” available at www.dbrsmorningstar.com.

The Coronavirus Disease (COVID-19) and the resulting isolation measures have caused an economic contraction, leading to sharp increases in unemployment rates and income reductions for many borrowers. DBRS Morningstar anticipates that payment holidays and delinquencies may increase in the coming months for many CPs, some meaningfully. The ratings are based on additional analysis and adjustments to expected performance as a result of the global efforts to contain the spread of the coronavirus. In its CP analysis of this programme, DBRS Morningstar increased the expected default rate for self-employed borrowers and assumed a moderate decline in residential property prices.

On 16 April 2020, the DBRS Morningstar Sovereign group released a set of macroeconomic scenarios for the 2020-22 period in select economies. These scenarios were last updated on 2 December 2020. For details see the following commentaries: https://www.dbrsmorningstar.com/research/370672/global-macroeconomic-scenarios-december-update and https://www.dbrsmorningstar.com/research/359903/global-macroeconomic-scenarios-application-to-credit-ratings. The DBRS Morningstar analysis considered impacts consistent with the moderate scenario in the referenced reports.

On 24 April 2020, DBRS Morningstar published a commentary outlining how the coronavirus crisis is likely to affect the DBRS Morningstar-rated CBs in Europe. For more details, please see: https://www.dbrsmorningstar.com/research/359987/covid-19-the-impact-on-european-covered-bonds and https://www.dbrsmorningstar.com/research/362712/european-structured-finance-covid-19-credit-risk-exposure-roadmap.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology applicable to the ratings is: “Rating and Monitoring Covered Bonds“ (27 April 2020).

DBRS Morningstar has applied the principal methodology consistently and conducted a review of the transaction in accordance with the surveillance section of the principal methodology.

A review of the transaction legal documents was not conducted as the legal documents have remained unchanged since the most recent rating action.

Other methodologies referenced in this transaction are listed at the end of this press release.

These may be found at: http://www.dbrsmorningstar.com/about/methodologies.

For a more detailed discussion of the sovereign risk impact on Structured Finance ratings, please refer to “Appendix C: The Impact of Sovereign Ratings on Other DBRS Morningstar Credit Ratings” of the “Global Methodology for Rating Sovereign Governments” at: https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments.

The sources of data and information used for these ratings include investor reports and loan-by-loan data on the CP as at 30 September 2020, as well as dynamic delinquencies and defaults data on Novo Banco’s mortgage book spanning from 2004 to Q3 2020 and 2002-2018, respectively, provided by the Issuer.

DBRS Morningstar did not rely upon third-party due diligence in order to conduct its analysis.

At the time of the initial ratings, DBRS Morningstar was not supplied with third-party assessments. However, this did not impact the rating analysis.

DBRS Morningstar considers the data and information available to it for the purposes of providing these ratings to be of satisfactory quality.

DBRS Morningstar does not audit or independently verify the data or information it receives in connection with the rating process.

The last rating action on this transaction took place on 29 September 2020, when DBRS Morningstar confirmed its “A” ratings on the OH issued under the Programme.

The lead analyst responsibilities for this transaction have been transferred to Covadonga Aybar.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com.

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.

Ratings assigned by DBRS Ratings GmbH, Sucursal en España are subject to EU and U.S. regulations only.

Lead Analyst: Covadonga Aybar, Vice President
Rating Committee Chair: Ketan Thaker, Managing Director
Initial Rating Date: 15 December 2015

DBRS Ratings GmbH, Sucursal en España
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Tel. +34 (91) 903 6500

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The rating methodologies used in the analysis of this transaction can be found at: http://www.dbrsmorningstar.com/about/methodologies.

-- Rating and Monitoring Covered Bonds (27 April 2020),
https://www.dbrsmorningstar.com/research/360260/rating-and-monitoring-covered-bonds.
-- Rating and Monitoring Covered Bonds Addendum: Market Value Spreads (27 April 2020),
https://www.dbrsmorningstar.com/research/360263/rating-and-monitoring-covered-bonds-addendum-market-value-spreads.
-- Global Methodology for Rating Banks and Banking Organisations (8 June 2020),
https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations.
-- Legal Criteria for European Structured Finance Transactions (11 September 2019),
https://www.dbrsmorningstar.com/research/350234/legal-criteria-for-european-structured-finance-transactions.
-- Interest Rate Stresses for European Structured Finance Transactions (28 September 2020), https://www.dbrsmorningstar.com/research/367292/interest-rate-stresses-for-european-structured-finance-transactions.
-- Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda (21 September 2020) and European RMBS Credit Model v 1.0.0.0,
https://www.dbrsmorningstar.com/research/366958/master-european-residential-mortgage-backed-securities-rating-methodology-and-jurisdictional-addenda.
-- Operational Risk Assessment for European Structured Finance Originators (30 September 2020), https://www.dbrsmorningstar.com/research/367603/operational-risk-assessment-for-european-structured-finance-originators.
-- Operational Risk Assessment for European Structured Finance Servicers (19 November 2020), https://www.dbrsmorningstar.com/research/370270/operational-risk-assessment-for-european-structured-finance-servicers.
-- Global Methodology for Rating Sovereign Governments (27 July 2020),
https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments.

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: http://www.dbrsmorningstar.com/research/278375.

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