New York, October 29, 2010 -- Moody's has assigned a definitive long-term rating of Aaa to the
Series 2 covered bonds issued by the Bank of Nova Scotia (rated Aa1,
Prime-1) under the terms of its U.S. $15 billion
Global Public Sector Covered Bond Programme. Bank of Nova Scotia
issued USD $2.5 billion fixed-rate Series 2 covered
bonds with a 5-year soft-bullet maturity.
Issuer: The Bank of Nova Scotia - Global Public Sector Covered
Series 2, Definitive Rating Assigned Aaa
The covered bonds are obligations of Bank of Nova Scotia and are also
backed by a cover pool consisting of Canadian residential mortgage loans
insured by the Canada Mortgage and Housing Corporation (CMHC, rated
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, the Bank of
Nova Scotia, is a Aa1-rated bank, and thus the likelihood
of default by the sponsor 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 refinancing risk.
Refinancing risk is the risk that assets may need to be sold following
an issuer default to pay off maturing series of covered bonds.
It arises due to the fact that there is typically a maturity mismatch
between the assets in the cover pool and the covered bonds. This
sale could result in a discounted price on the assets being sold.
The rating takes into account the following factors:
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. Minimum overcollateralization of approximately 3%,
corresponding to a maximum asset percentage of 97%.
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 P-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
Covered bond ratings are determined after applying a two-step process:
expected loss analysis and 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
Aa1, and the stressed losses on the cover pool assets following
The Cover Pool Losses for this programme are 12.36%.
This is an estimate of the losses Moody's currently models in the
event of issuer default. Cover Pool Losses can be split between
Market Risk of 12.02% and Collateral Risk of 0.34%.
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 the Collateral Score which for this programme
is currently 0.50%. This low Collateral Score is
achievable due to the low level of credit risk on the CMHC insured mortgages.
TPI Framework: Moody's assigns a "timely payment indicator"
(TPI) which indicates the likelihood that timely payment will be made
to covered bondholders 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.
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 5 notches, meaning that if
issuer's rating were downgraded to Baa1 then the covered bonds could
no longer maintain a Aaa rating.
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.
Under our current assumptions, the Aaa rating of the covered bonds
can withstand a downgrade of the Issuer to Aa3 without the need to increase
the amount of committed overcollateralization. If the Issuer were
to be downgraded to between A1 and A3, it may be possible for the
Issuer to maintain the Aaa rating of the covered bonds if the Issuer were
to choose to increase the amount of committed overcollateralilzation.
However, this may require an amendment to the program documents
to make this amount contractually committed.
Based on our current assumptions, a downgrade of the Issuer to A1
would require committed overcollateralization of 8% to maintain
the Aaa rating of the covered bonds.
A downgrade to A2 would require committed overcollateralization of 10%
to maintain the Aaa rating of the covered bonds.
The principal methodology used in rating this transactions 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
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.
Asst Vice President - Analyst
Structured Finance Group
Moody's Investors Service
MD - Structured Finance
Structured Finance Group
Moody's Investors Service
Moody's Investors Service
Moody's assigns definitive rating to Bank of Nova Scotia Series 2 covered bonds
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