Fitch Ratings has today assigned Bank of Montreal's (BMO, rated 'AA-'/Stable Outlook/'F1+') forthcoming Series 3 USD benchmark issue of mortgage covered bonds an expected 'AAA'(exp) rating. The fixed rate paying bonds are guaranteed by BMO Covered Bond Trust, a special purpose trust established for the programme with restricted permitted activities. The final rating is contingent upon the receipt of final documents conforming to information already received. Fitch has also affirmed the 'AAA' rating on the other outstanding series for the total balance of CAD-equivalent 3.5 billion.
The expected rating is based on BMO's long-term Issuer Default Rating (IDR) of 'AA-' and a Discontinuity Factor (D-Factor) of 18.1%, the combination of which enables the mortgage covered bonds to be rated 'AAA' on a probability of default (PD) basis because the overcollateralization (OC) is sufficient to sustain this level of stress. The programme's contractual asset percentage (AP) of 95% is equal to the AP supporting the assigned rating. Major drivers of the high supporting AP are the short tenors of the cover assets, which are generally two-to-five years compared with the 20-to-30 years seen in most jurisdictions, and the higher assumed liquidity of the Canada Mortgage and Housing Corporation (CMHC)-insured cover assets. If CMHC lost the full backing of the Government of Canada, or if the Government of Canada suffered a downgrade, Fitch would revise the credit given to the CMHC insurance, which could lead to weaker liquidity and lower recovery expectations on the assets and subsequently a higher D-Factor and lower AP to support the rating.
As of Nov. 30, 2010, the cover pool consisted of 44,931 first lien, CMHC-insured residential mortgage loans totaling CAD7.83 billion with a weighted average (WA) current loan to value (LTV) of 66.75%. In an 'AAA' scenario, Fitch has calculated a cumulative weighted average frequency of foreclosure (WAFF) for the cover assets of 15.70% and a weighted average recovery rate (WARR) of 96.5%, which reflects the benefit of the CMHC insurance on the loans. As limited performance data are available on the Canadian market, the agency's default analysis is based on the U.S. residential mortgage default model criteria with risk multipliers for Canadian provinces mapped to U.S. states with comparable economic characteristics and outlooks.
An interest rate swap is in place with BMO to transform interest collections from the cover assets into CAD floating-rate. Liability swaps are in place, also with BMO, to hedge the currency and basis risk arising from the difference in denominations and interest rates between the cover asset and liabilities. The agency applies its structured finance counterparty criteria to the analysis of the swap arrangements. However, the covered bond analysis deviates from the counterparty criteria with respect to interest rate stresses. Given BMO's short-term IDR of 'F1+', which the agency views as commensurate with long-term ratings between 'AA-' and 'AAA', Fitch relies on the recourse to the issuer and expects the issuer to manage the interest rate risks of the covered bonds. The agency would apply its Canadian interest rate stresses if BMO's short-term IDR were to fall below 'F1+' resulting in a slightly higher level of OC in line with the same rating stress. The impact of applying the LIBOR stresses would be limited for this programme because the asset swap covers most interest rate risks except those associated with non-performing loans which would result in a small percentage of the cover pool being unhedged.
The agency's supporting AP will be affected, among other things, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuances.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--'Covered Bonds Rating Criteria', dated 13 Aug. 2010;
--'Assessment of Liquidity Risks in Covered Bonds', dated 16 Aug. 2010;
--'ResiLogic: U.S. Residential Mortgage Loss Model Criteria', dated 11 Aug. 2009;
--'National Risk Index, State- and MSA-level Risk Multipliers in ResiLogic', dated 22 Dec. 2010;
--'Counterparty Criteria for Structured Finance Transactions', dated 22 Oct. 2009;
--'Counterparty Criteria for Structured Finance Transactions: Derivative Addendum', dated 23 Oct. 2009.
Applicable Criteria and Related Research:
Counterparty Criteria for Structured Finance Transactions
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=475588
Counterparty Criteria for Structured Finance Transactions: Derivative Addendum - Amended
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=475606
National Risk Index, State- and MSA-level Risk Multipliers in ResiLogic
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=589065
ResiLogic: U.S. Residential Mortgage Loss Model Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=461916
Assessment of Liquidity Risks in Covered Bonds
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=540786
Covered Bonds Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=547527
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