OREANDA-NEWS. Fitch Ratings has affirmed the 'AAA'/Stable Outlook rating on the Bank of Nova Scotia (BNS;

'AA-'/Stable Outlook/'F1+') structured mortgage covered bonds following the annual review of the program.

The bank's structured program remains in wind-down following the introduction of covered bond legislation in 2012 which prohibits issuance of covered bonds secured by insured mortgages. The four outstanding bonds in this program are due to mature in August 2016, January 2017 and March 2017.

KEY RATING DRIVERS

The 'AAA' rating of BNS's structured mortgage covered bonds is based on the issuer's Long-Term Issuer Default Rating (IDR) of 'AA-', Fitch's unchanged Discontinuity Cap (D-Cap) of 3 notches (moderate high risk), and the program's contractual asset percentage (AP) of 95% that Fitch takes into account in its analysis, which is equal to Fitch's 'AAA' breakeven AP of 95%. The Stable Outlook for the covered bonds rating is due to the Stable Outlook on the Canadian sovereign and on BNS's IDR. Since bail-in is not an explicit provision under the current Canadian framework, the IDR remains, in Fitch's view, a satisfactory indicator of the likelihood that the recourse against the cover pool would be enforced, and no IDR uplift is applicable.

The 95% 'AAA' breakeven AP, corresponding to a breakeven overcollateralization (OC) of 5.3%, is driven by the cover pool's asset disposal loss of 5.1% followed by a credit loss which increased the OC by 0.6%. The cash flow valuation component decreased the OC by 0.5%. The 0.6% 'AAA' credit loss represents the impact on the breakeven OC from the 17.75% weighted average (WA) frequency of foreclosure and the 96.5% WA average recovery rate for the mortgage cover assets. The breakeven AP considers whether timely payments are met in an 'AA' scenario and tests for recoveries given default of at least 91% in a 'AAA' scenario, this is why the sum of the breakeven OC drivers is higher than BNS's 'AAA' breakeven OC.

Canadian covered bond program documents include a feature called the Selected Assets Required Amount (SARA) clause, which places some conditions on the sale of assets in the event of an issuer default. Fitch has considered the impact of this clause by modelling an issuer default in each of the first three quarters (after quarter three there are no more bond maturities) and determined that the OC level is sufficient for all possible sale periods under a given rating scenario.

The following criteria variations were applied during the analysis of this program. Fitch utilized its Canadian RMBS Loan Loss Model Criteria for the asset analysis of the BNS structured covered pool. For the cash flow analysis, Fitch assumed that all the defaults on the assets occurred in year one, the servicing fee was 0.32%, the negative spread on cash reinvestments was 0.10%, and prepayment assumptions of 5% and 30% were used. The rating impact of applying these criteria variations is undetermined.

RATING SENSITIVITIES

The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) the Issuer Default Rating is downgraded by three or more notches to 'A-' or below; (ii) the number of notches represented by the D-Cap is reduced to 0; or (iii) the asset percent that Fitch considers in its analysis increases above Fitch's 'AAA' breakeven level of 95%.

The Fitch breakeven asset percent for the covered bond rating will be affected by, among others, the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuance. Therefore the breakeven asset percent to maintain the covered bond rating cannot be assumed to remain stable over time.