TEXT-Fitch affirms Bank of Montreal covered bonds
Aug 14 - Fitch Ratings has affirmed the 'AAA' ratings of Bank of Montreal's (BMO; rated 'AA-/F1+', Stable Outlook by Fitch) CAD-equivalent 9.1 billion outstanding mortgage covered bonds. The bonds are guaranteed by BMO Covered Bond Trust, a special-purpose trust established for the program with restricted permitted activities. The ratings are based on BMO's Long-term Issuer Default Rating (IDR) of 'AA-' and a Discontinuity Factor (D-Factor) of 19.7%, the combination of which enables the covered bond to be rated as high as 'AAA' on a probability of default (PD) provided the minimum overcollateralization (OC) the issuer commits to in the program documentation is sufficient to sustain this level of stress. The program's contractual maximum asset percentage (AP) of 95% is consistent with the Fitch supporting AP of 95%, which is commensurate with an 'AAA' stress scenario. The supporting AP level for a given 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 issuances. As of April 30, 2012, the cover pool consisted of 57,542 first-lien, Canada Mortgage and Housing Corporation (CMHC)-insured residential mortgage loans totaling CAD10.5 billion with a weighted-average (WA) original loan to value (LTV) of 71.3% (as calculated by Fitch). In an 'AAA' scenario, Fitch has calculated a cumulative weighted-average frequency of foreclosure (WAFF) of 15.7% and a weighted-average recovery rate (WARR) of 96.5%, which reflects the benefit of the CMHC insurance on the loans. It is also noted that as a deviation to the 'Covered Bonds Rating Criteria', dated May 30, 2012, a biennial on-site review of the issuer was not conducted in connection with this program. Because the program is in wind-down and assets are expected to only be added for maintaining OC levels Fitch determined that an onsite review in connection with the existing program would not be necessary at this time. The agency expects to conduct a full review in late 2012/early 2013 when the covered bond registry is in effect as part of the recently enacted covered bond legislation. In addition, the agency has taken into account the tight underwriting guidelines put in place by the Department of Finance Canada with respect to CMHC-insured mortgages as well as CMHC's on-going oversight of approved lenders. If CMHC lost the full backing of the Government of Canada, or if the Government of Canada's rating suffered a downgrade, Fitch would revise the credit given to the CMHC guarantee on the NHA-MBS as well as to the insurance provided by CMHC on the mortgage loan portion of the cover pool. This could lead to weaker liquidity assumed for both the NHA-MBS and the mortgage assets (together, the cover assets) as well as higher credit risk expectations for the cover assets. As a result, the D-Factor would likely increase and the AP supporting the current covered bonds rating would likely decrease. The weighted average life (WAL) of the assets in the cover pool is approximately 2.7 years, compared to the WAL of 2.9 years for the covered bonds. The assets are fixed and variable rate, CAD-denominated, whereas the bonds are fixed rate and denominated in USD and EUR. Interest rate and currency risks on the covered bonds are hedged via swaps with BMO as counterparty with collateral posting and replacement provisions in line with Fitch criteria. The rating action also incorporates the revision of refinancing spread assumptions, which are used to estimate the stressed sale price for the cover pool that an alternative manager would liquidate in the aftermath of an issuer default. The net present value (NPV) of cover pools is determined by discounting the value of the assets at a rate reflective of the revised refinancing spreads. The NPV of the assets is consistent with previous assumptions given the credit loss protection on the assets provided by the CMHC insurance which insulates a potential buyer from increasing stress in the housing market. All else being equal, the covered bonds could remain rated 'AAA' provided BMO's IDR is at least 'BBB+'. However, on May 30, 2012 Fitch published a report titled 'Exposure Draft: Global Covered Bonds Rating Criteria'. The report proposes enhancements to the covered bonds rating criteria in order to increase transparency and reflect Fitch's updated views of systemic risk and cover pool liquidity. Although Fitch anticipates there will be no impact on BMO's covered bond ratings if the exposure draft proposals were implemented as proposed, it could have an impact on the minimum IDR at which the ratings could be maintained at 'AAA'.