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Rating Action:

Moody's assigns provisional Aaa rating to NBC's series 1 $USD-denominated covered bonds

Global Credit Research - 25 Jan 2011

New York, January 25, 2011 -- Moody's has assigned the provisional long-term rating of Aaa to the U.S. dollar-denominated Series 1 covered bonds issued by the National Bank of Canada (NBC, rated Aa2, Prime-1) under the terms of its USD 5 billion Global Public Sector Covered Bond Programme.

Issuer: National Bank of Canada Global Public Sector Covered Bond Programme

Public Sector Series 1 , Assigned (P)Aaa

RATING RATIONALE

The covered bonds are obligations of NBC 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, NBC, is a bank with a long term rating of Aa2, 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 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.

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, and the stressed losses on the cover pool assets following issuer default.

The cover pool losses for this programme are 10.98%. 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 10.48% 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, the program is subject to minimal 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 aggregate of borrower deposits in excess of CAD 100,000 is roughly 0.42% of the current pool balance.

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.

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 92.5%.

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 provisional Aaa rating to NBC's series 1 $USD-denominated covered bonds
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