FITCH AFFIRMS ROYAL BANK OF CANADA'S LEGISLATIVE MORTGAGE COVERED BONDS AT 'AAA'; OUTLOOK STABLE

The Royal Bank of Canada's (RBC; 'AA'/'F1+'/Outlook Negative) legislative mortgage covered bonds at 'AAA' with a Stable Rating Outlook.

KEY RATING DRIVERS

The 'AAA' rating on RBC's legislative mortgage covered bonds is based on the issuer's 'AA' Issuer Default Rating (IDR) and the unchanged Discontinuity Cap (D-Cap) of 3 (moderate high risk). Fitch also takes into account the program's contractual asset percentage (AP) of 93%, which is more conservative than Fitch's 'AAA' breakeven AP of 94%.

The Stable Outlook for the covered bonds rating is due to the Stable Outlook on the Canadian sovereign and RBC's support of the program. Since bail-in is not an explicit provision under the current Canadian framework, 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.

The 94% 'AAA' breakeven AP, corresponding to a breakeven over collateralization (OC) of 6.4% is driven by the cover pool's 'AAA' stress credit loss of 6.7% followed by the 'AAA' stress asset disposal loss which increased the OC by 1.3%. The 'AAA' stress cash flow valuation component leads to a decrease in the 'AAA' breakeven OC by .7%. The 6.7% 'AAA' credit loss represents the impact on the breakeven OC from the 18.56% weighted average (WA) default rate and the 66.33% WA average recovery rate for the mortgage cover assets. The breakeven AP considers whether timely payments are met in a '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.

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 before the first benchmark covered bond maturity and determined that the over collateralization 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 the Canadian Residential Mortgage Loan Loss Model Criteria for the asset analysis of the RBC covered pool. For the cash flow analysis, Fitch assumed that the defaults on the assets occurred at 25% per year for four years, the servicing fee was .32%, the negative spread on cash reinvestments was .10%, and prepayment assumptions of 5% and 30% were used.

RATING SENSITIVITIES

The 'AAA' rating would be vulnerable to downgrade if any of the following occurs: (i) the 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 others, 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.