OREANDA-NEWS. Fitch Ratings has placed Pekao Bank Hipoteczny's (PBH, A-/Stable/F2) and mBank Hipoteczny's (mBH, BBB-/Positive/F3) mortgage covered bonds - rated 'A' and 'BBB' respectively - on Rating Watch Positive (RWP). The rating action reflects the potential for upgrades following the amendment of the Polish Covered Bond legislation, in force as of 1 January 2016, and following the delivery of substantial performance data by mBH at end-2015.

Fitch will seek to resolve the RWP of PBH in 1H16 after a full review, for which it may receive a full set of historical performance data on top of the existing limited data. For mBH's mortgage covered bonds Fitch expects to resolve the RWP in 1Q16 once the review of the historical performance data received has been completed.

The change in legislation has no impact on the ratings of mBH's public sector covered bonds as their rating is capped due to data limitations on borrower information, which will remain in place, reflecting strict data protection standards.

KEY RATING DRIVERS
Fitch expects to review the D-Cap of '0' for all three Polish programmes following clarifications and the receipt of legal opinions on the legislation amendment. The agency expects this review to result in a higher D-Cap, allowing for an uplift above the issuer`s IDR, as adjusted by the IDR uplift, provided it is not constrained by overcollateralisation (OC).

So far, the mBH programmes were analysed based on a limited rating uplift by testing whether recoveries on defaulted covered bonds exceed 51% when conservative default and recovery assumptions are applied, in line with a one-notch recovery uplift. Fitch expects that mBH's performance data and PBH's additional performance data, if received, would lead to a full and robust analysis and higher ratings.

However, both mortgage programmes exhibit large unhedged foreign currency (FX) positions on their assets and liabilities. Even after netting positions of the same currency with comparable weighted average lives of the assets and liabilities, substantial unhedged FX positions on the asset side remain. Fitch has noted in its "Exposure Draft: Treatment of Residual Foreign Exchange Exposures in Covered Bonds" that, if adopted after considering market feedback, it may not give any credit in its analysis to assets which the agency considers above a non-residual FX exposure, so the level of OC taken into account by Fitch could decrease significantly. Fitch expects that the FX exposures will limit the number of notches of upgrade for the ratings.

The current D-Cap of '0' was driven by the absence of any liquidity protection before the amendment. The revised legislation has now introduced a six-month short-term liquidity reserve; a mandatory 12-month extension period and a switch to pass-through mechanism if the bonds cannot be repaid at the extended maturity date. These features greatly mitigate interest and principal payment risk.

Additionally the amendments have abolished time subordination risk for longer-dated covered bonds series. This risk was reflected when testing recoveries on defaulted bonds. With time subordination all but the last series have to be repaid in full and the last maturing covered bond series has to have a minimum recovery of 51% in line with a one-notch recovery uplift or 91% for a two notch uplift. Under the amended legislation the minimum recovery of 51% or 91% would apply to all outstanding series. This is expected to have a positive impact on the OC levels needed for a given rating.

RATING SENSITIVITIES
All else being equal the RWP on the 'A' rating of PBH's mortgage covered bonds will be resolved when (i) legal opinions and outstanding clarifications have been received and (ii) historical performance data has been received and reviewed or if Fitch is not provided with additional data.

All else being equal the RWP on the 'BBB' rating of mBH's mortgage covered bonds will be resolved before end-1Q16 when (i) legal opinions and outstanding clarifications have been received and (ii) the review of historical performance data has been completed.