New York, January 25, 2011 -- Moody's has assigned the long-term rating of Aaa to the U.S.
dollar-denominated Series 3 covered bonds issued by the Bank of
Montreal (BMO, rated Aa2 on review for downgrade, Prime-1)
under the terms of its EUR 7 billion Global Public Sector Covered Bond
Programme.
Issuer: BMO Global Public Sector Covered Bond Programme
USD 1.5 Billion Public Sector Series CB3 Due 1/25/2016, Assigned
Aaa
RATING RATIONALE
The covered bonds are obligations of BMO and are also backed by a cover
pool consisting of Canadian residential mortgage loans insured by the
Canada Mortgage and Housing Corporation (CMHC, rated Aaa,
Prime-1).
Since the covered bondholders first have recourse to the issuer,
we assume that the issuer will continue to make all payments due to covered
bond holders while it remains solvent. We use the senior unsecured
debt rating of the issuer as a means to determine the likelihood of default
for a typical covered bond. The issuing bank, BMO,
is a bank with a long term rating of Aa2 on review for downgrade,
and thus the likelihood of default by the issuer is very low.
Additionally, we analyze the cover pool to determine the potential
severity of loss on the covered bonds in the event that investors need
to rely on the cover pool to generate payments on the bonds after an issuer
default. Our analysis of losses on the cover pool focuses on losses
due to credit risk and market risks. Credit risk is the risk of
actual losses due to asset defaults. The market risks that can
arise are due to currency and interest rate mismatches between the cover
pool assets and the covered bonds, as well as refinance risk.
Refinance risk arises due to the fact that there is typically a maturity
mismatch between the assets in the cover pool and the covered bonds,
which necessitates a sale of all or a part of the cover pool in order
to pay off a maturing series of covered bonds. This sale could
result in a discounted price on the assets being sold.
The structure of this programme addresses cover pool losses with the following
attributes:
1. Cover pool assets
Each mortgage loan in the cover pool is required to be insured by the
Canada Mortgage and Housing Corporation (CMHC, rated Aaa,
P-1), a Canadian federal Crown corporation, wholly
owned by the Government of Canada, whose obligations carry the full
faith and credit of the Government of Canada. CMHC insurance covers
the principal balance of the loan and up to 12 months of accrued and unpaid
interest in full. CMHC insurance not only strengthens the credit
quality of the loans, but also should improve their liquidity in
the event they need to be sold.
2. Overcollateralization
3. Swaps to mitigate interest rate and currency mismatches
4. A twelve months extension period for soft bullet covered bonds
and a Pre-Maturity Test designed to require the buildup of sufficient
liquidity to pay off any series of covered bonds that mature within 12
months if the short term rating of the issuer drops below Prime-1
for hard bullet covered bonds
Moody's rating addresses the expected loss posed to investors.
Moody's rating addresses only the credit risks associated with the transaction;
non-credit risks have not been addressed, but may have a
significant effect on the yield to investors.
KEY RATING ASSUMPTIONS/FACTORS
Moody's determines its covered bond ratings by applying a two-step
process: an expected loss analysis and a TPI framework analysis.
EXPECTED LOSS: Moody's determines a rating based on the expected
loss on the bond. The primary model used is Moody's Covered
Bond Model (COBOL) which determines expected loss as a function of the
issuer's probability of default, measured by its rating of
Aa2 on review for downgrade, and the stressed losses on the cover
pool assets following issuer default. Moody's has reason
to believe that the issuer would support the program in the event of a
downgrade to its rating below Aa2. As a result, the provisional
ratings for the Series CB3 covered bonds and the existing series of covered
bonds is Aaa, not on review for downgrade.
The cover pool losses for this programme are 11.49%.
This is an estimate of the losses Moody's currently models in the
event of issuer default. Moody's splits cover pool losses
between losses due to market risk of 10.99% and collateral
risk of 0.50%. Market risk measures losses as a result
of refinancing risk and risks related to interest rate and currency mismatches
(these losses may also include certain legal risks). Collateral
risk measures losses resulting directly from the credit quality of the
assets in the cover pool. Collateral risk is derived from Moody's
Collateral Score which is currently 0.50% for this programme.
The low level of credit risk on the CMHC insured mortgages primarily drives
the low Collateral Score.
In addition, provisions in the loan documents mitigate set-off
risk. Set-off risk is the risk that following an issuer
default, a borrower would set-off amounts he owes on his
mortgage loan against amounts in his bank accounts exceeding CAD100,000
that the issuer holds. The program documents require each loan
to contain language restricting the borrower's set-off rights.
TPI Framework: Moody's assigns a "timely payment indicator"
(TPI) which indicates the likelihood that covered bondholders will receive
timely payments following issuer default. The effect of the TPI
framework is to limit the covered bond rating to a certain number of notches
above the issuer's rating. Moody's has assigned a TPI
of Probable to this programme.
SENSITIVITY ANALYSIS
The robustness of a covered bond rating largely depends on the credit
strength of the issuer.
The number of notches by which the issuer's rating may be downgraded
before the covered bonds are downgraded under the TPI framework is measured
by the TPI Leeway. Based on the current TPI of Probable,
the TPI Leeway for this programme is 4 notches, meaning that the
covered bonds could no longer maintain a Aaa rating if the issuer's
rating were downgraded to Baa1.
The transaction currently has a maximum asset percentage of 97%.
Moody's views this as the contractually obligated asset percentage
of the issuer. As a result, Moody's does not give credit
to a lower stated asset percentage when determining the expected loss.
With an asset percentage of 97%, the programme would be downgraded
if the issuer were downgraded to A1 or below. In order for the
programme to be able to withstand a downgrade of the issuer to A2 and
still maintain a Aaa rating, the contractually obligated asset percentage
would need to be 92%.
RATING METHODOLOGY
The principal methodology used in rating this transaction was Moody's
Rating Approach to Covered Bonds rating methodology published in March
2010. Other methodologies and factors that may have been considered
in the process of rating this issuer can also be found on Moody's website.
In addition, Moody's publishes a weekly summary of structured finance
credit, ratings and methodologies, available to all registered
users of our website, at www.moodys.com/SFQuickCheck
REGULATORY DISCLOSURES
Information Sources used to prepare the credit rating are the following:
parties involved in the ratings, public information.
Moody's Investors Service considers the quality of information available
on the issuer or obligation satisfactory of the purposes of assigning
a credit rating.
Moody's adopts all necessary measures so that the information it uses
in assigning a credit rating is of sufficient quality and from sources
Moody's considers to be reliable including, when appropriate,
independent third-party sources. However, Moody's
is not an auditor and cannot in every instance independently verify or
validate information received in the rating process.
Please see ratings tab on the issuer/entity page on Moodys.com
for the last rating action and the rating history.
The date on which some Credit Ratings were first released goes back to
a time before Moody's Investors Service's Credit Ratings were fully digitized
and accurate data may not be available. Consequently, Moody's
Investors Service provides a date that it believes is the most reliable
and accurate based on the information that is available to it.
Please see the ratings disclosure page on our website www.moodys.com
for further information.
Please see the Credit Policy page on Moodys.com for the methodologies
used in determining ratings, further information on the meaning
of each rating category and the definition of default and recovery.
New York
Todd Swanson
Asst Vice President - Analyst
Structured Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
New York
Linda Stesney
MD - Structured Finance
Structured Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
Moody's Investors Service
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
Moody's assigns Aaa rating to BMO's series 3 $USD-denominated covered bonds
