DBRS Morningstar Confirms the Bank of Nova Scotia Global Registered Covered Bonds, Series CBL34 at AAA Post-Reopening

DBRS Limited (DBRS Morningstar) confirmed the rating of AAA on the Covered Bonds, Series CBL34 (Series CBL34) issued under the Bank of Nova Scotia (Global Registered Covered Bond Program) (the Registered Program) following the reopening of Series CBL34. BNS reopened Series CBL34 by issuing an additional GBP 100 million with the same coupon rate (Compounded Daily SONIA (Sterling Overnight Index Average) + 1.00%) and maturity date (March 14, 2025) as the initial issuance. The total amount of the Series CBL34 covered bonds outstanding after the reopening is GBP 1.6 billion. 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 for The Bank of Nova Scotia (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 A (low).
-- 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.
-- A level of overcollateralization (OC) of 5.5% (based on the Asset Percentage of 94.8% as at June 29, 2022) 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 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 $62.3 billion as at June 29, 2022. The Scotia Total Equity Plan (STEP) loans may have amortizing and nonamortizing revolving loan parts secured by the same first lien. Only the amortizing loan parts of the STEP loans 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 DBRS Morningstar 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 40.12% (based on indexed property value) reported by BNS as at June 29, 2022.

(2) BNS 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 on 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 (low), and the 12-month maturity extension upon default by BNS.

BNS is one of Canada’s largest banks as measured by assets as at April 30, 2022, with assets of $1,288.5 billion and total equity of $72.0 billion. It is the initial servicer of the mortgages in the Cover Pool.

More details on the Cover Pool and the Registered Program are provided in the Monthly Canadian Covered Bond Report, which is available on www.dbrsmorningstar.com or by contacting us at info@dbrsmorningstar.com.

ESG CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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

The principal methodology is Rating and Monitoring Covered Bonds (April 22, 2022), 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.

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.

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 the Registered Program took place on June 8, 2022, when DBRS Morningstar discontinued the rating on the Covered Bonds, Series CBL32.

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: Fanfei Gong, Vice President, Canadian Structured Finance, Global Structured Finance
Rating Committee Chair: Tim O'Neil, Managing Director, Head of Canadian Structured Finance
Initial Rating Date: March 25, 2014

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 (April 22, 2022)
Link: https://www.dbrsmorningstar.com/research/395642
Predictive model: Canadian RMBS Model (November 2021; Version 5.0.0.3)
Link: https://www.dbrsmorningstar.com/models/