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