Fitch Affirms Royal Bank of Canada's Legislative Mortgage Covered Bonds at 'AAA'
OREANDA-NEWS. Fitch Ratings has affirmed the 'AAA' rating with a Stable Outlook on the Royal Bank of Canada's (RBC; 'AA'/'F1+'; Outlook Negative) legislative mortgage covered bonds.
KEY RATING DRIVERS
RBC's LEGISLATIVE MORTGAGE COVERED BONDS: The 'AAA' rating on RBC's legislative mortgage covered bonds is based on the issuer's Issuer Default Rating (IDR) of 'AA', Fitch's unchanged Discontinuity Cap (D-Cap) of 3 (moderate high risk), which allows for a maximum achievable rating on the covered bonds of 'AAA' on a probability of default (PD) basis. The rating is also based on the program's contractual asset percentage (AP) of 93% that Fitch takes into account in its analysis which provides more protection than the 94% 'AAA' breakeven AP.
The 94% 'AAA' breakeven AP, corresponding to a breakeven overcollateralization (OC) of 6.4% is driven by the cover pool's credit loss component of 5.7%, followed by the cash flow valuation component which increases the breakeven OC by 1.4%. The asset disposal loss leads to an increase in the 'AAA' breakeven OC by 1.2%. The 5.7% 'AAA' credit loss represents the impact on the breakeven OC from the 16.60% weighted average (WA) default rate and the 67.3% 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 an 'AAA' scenario, this is why the sum of the breakeven OC drivers is higher than RBC's 'AAA' breakeven OC.
Under the current Canadian banking legislation bail-in is not an explicit provision; therefore, in Fitch's view, the IDR remains a satisfactory indicator of the likelihood that the recourse against the cover pool would be enforced, and no IDR uplift is applicable.
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 six quarters and in every quarter with a covered bond maturity date to ensure that OC would be sufficient for all possible sale periods under a given rating scenario.
Fitch is currently in the process of fine-tuning its approach to the SARA clause. Following this review, expected to be completed in the latter half of 2016, Fitch will re-run the cash flow modelling on these programs to evaluate any impact on the break-even AP for the ratings.
RATING SENSITIVITIES
The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) RBC's IDR is downgraded by four or more notches to 'A-' or below; or (ii) the AP that Fitch considers in its analysis increases above Fitch's 'AAA' breakeven level of 94%. The covered bonds' rating could be maintained even if the D-Cap was reduced to 0 (full discontinuity), subject to a satisfactory level of AP, given the issuer's current IDR of 'AA' which enables the bonds to reach 'AAA' taking only recoveries into account.
The Fitch breakeven AP for the covered bond rating will be affected, amongst other factors, by 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 AP to maintain the covered bond rating cannot be assumed to remain stable over time.
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