Fitch has placed the mortgage covered bonds of Pekao Bank Hipoteczny and mBank Hipoteczny on Rating Watch Positive, reflecting the potential for upgrades after a revision of Polish covered bond legislation and after having received performance data from mBank.

The amendments to legislation governing Polish covered bonds and mortgage banks took effect on 1 January, introducing maturity extensions and conditional pass-through techniques, among other revisions.

Fitch currently rates Pekao Bank’s and mBank’s mortgage covered bonds A and BBB, respectively.

After receiving clarifications and legal opinions on the amendments to the legislation, Fitch said it expects to review its Discontinuity Caps (D-Caps) for the programmes

The rating agency said the current D-Caps of 0 were driven by the absence of any liquidity protection before the amendments. It noted that the revised legislation has 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,” Fitch said.

Fitch added that the amendments have abolished time subordination risk for longer dated covered bond series, which it expects to have a positive impact on the overcollateralisation (OC) levels needed for a given rating

The rating agency expects the reviews to result in higher D-Caps for the programmes, allowing for an uplift above the issuers’ Issuer Default Ratings (IDRs), as adjusted by IDR uplift, provided they are not constrained by OC levels.

Fitch said that so far, mBank’s mortgage covered bonds 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.

The rating agency expects that mBank’s performance data and additional Pekao Bank performance data, if received, would lead to a full and robust analysis and higher ratings.

However, Fitch noted that the programmes exhibit large unhedged foreign currency positions on their assets and liabilities.

Fitch in November proposed amendments to its criteria for residual foreign exchange (FX) exposures in covered bonds. It said that if the proposals are adopted after it considers market feedback, it may not give any credit in its analysis to assets it considers above a non-residual FX exposure, meaning the level of OC taken into account by Fitch could decrease significantly.

Fitch therefore said that it expects that FX exposures to limit the number of notches of upgrade for the programmes’ ratings.

The rating agency said it will seek to resolve the review of Pekao Bank in the first half of the year after a full review, for which it may receive a full set of historical performance data on top of existing limited data. It expects to resolve the review on mBank’s mortgage covered bonds in the first quarter, once a review of the historical performance data it has received has been completed.

The rating agency added that the amendments to the legislation have no impact on the ratings of mBank’s public sector covered bonds, as their rating is capped due to data limitations on borrower information, which will remain in place.