OREANDA-NEWS. Fitch Ratings has affirmed the Long-term Issuer Default Ratings (IDRs) of Poland-based Bank Pekao SA (Pekao) and its mortgage bank subsidiary, Pekao Bank Hipoteczny (PBH), at 'A-' with Stable Outlook. A full list of rating actions is provided at the end of this commentary.

The rating actions follow the revision of the Outlook for Pekao's parent Unicredit S.p.A. (UniCredit) on 26 March 2016 (see 'Fitch Revises UniCredit's Outlook to Negative; Affirms at 'BBB+'' at www.fitchratings.com).

KEY RATING DRIVERS
IDRS, SUPPORT RATINGS AND NATIONAL RATINGS
The IDRs are based on the intrinsic strength of Pekao, as reflected in its Viability Rating (VR) of 'a-' (see below). PBH's ratings are equalised with those of its direct parent and share the same Stable Outlook, reflecting Fitch's view that it is a core subsidiary of Pekao.

The Support Rating of Pekao reflects Fitch's view of a high probability of potential support from the bank's 50.1% shareholder UniCredit (BBB+/Negative/bbb+).

VR
The 'a-' VR of Pekao reflects its strong standalone credit profile, underpinned mainly by strong capitalisation, but also reflecting: i) a solid franchise; ii) rather resilient performance, resulting in healthy internal capital generation; iii) sound asset quality; iv) strong liquidity and a stable funding base; and v) low exposure to risks related to foreign currency mortgages.

The VR of Pekao is one notch above the IDR of its parent, also driven by its VR, and this differential could widen to two notches in case of a downgrade of UniCredit to 'BBB'. The rating differential, with the potential to increase to two notches, reflects the low dependence of Pekao on group and wholesale funding, its robust domestic franchise and a strong domestic regulator, which in Fitch's view will likely continue to prevent any sizable upstreaming of subsidiary capital to the parent bank.

Capitalisation is a rating strength for Pekao and a key driver of its 'a-' VR. This strength is based on the bank's high capital ratios, conservative risk management, sufficient coverage of impaired loans by reserves, moderate concentrations in the loan book, low exposure to foreign currency mortgages and healthy internal capital generation. At end-2015, the Fitch Core Capital (FCC) ratio stood at 19.9%; the highest among rated Polish peers.

Despite pressures on revenues and one-off costs related to additional contributions to the Deposit Insurance Fund, Pekao delivered reasonable profitability for 2015 with a return on average equity (ROAE) of close to 10% and a return on average assets (ROAA) of 1.4%. This year is likely to be somewhat more challenging due to a still low interest rate environment and additional fiscal levy.

Pekao's asset quality improved slightly faster than for the market over the last 12 months and the impaired loan ratio stood at 6.6% at end-2015, despite Pekao, unlike some of its peers, not being an active seller of non-performing loan (NPL) portfolios. Coverage of impaired loans by specific provisions is at a reasonable level 72%, which is better than the sector average of 59%.

The loan-to-deposit ratio is close to 100%, but liquidity is strong, benefitting from a stable funding position, based on balanced, diversified customer deposits, a low share of wholesale funding and an ample equity base.

RATING SENSITIVITIES
The Stable Outlook on Pekao's Long-term IDR reflects that on the bank's standalone risk profile. This in turn reflects (i) Fitch's expectation that the bank's risk appetite and financial metrics will not change significantly in the near- to medium-term; (ii) the Stable Outlook on Poland's sovereign ratings; and (iii) Fitch's view that Pekao is unlikely to upstream capital to its parent to an extent that would significantly weaken its capitalisation.

Pekao could be downgraded in case of (i) a significant weakening of the bank's financial metrics, for example due to sharp deterioration in performance; (ii) a downgrade of Poland; or (iii) a change in Fitch's view on the fungibility of capital between Pekao and its parent, making the bank's high capital ratios less sustainable in the long term.

However, Pekao's ratings will probably be unaffected by (i) a downgrade of Unicredit by one notch; or (ii) the imposition by the Polish authorities of a solution for foreign currency mortgages, which results in losses for banks. In Fitch's view, the imposition of a very adverse solution is unlikely. However, even if such solution is implemented losses sustained by Pekao would not be sufficient to warrant a rating downgrade, given the limited size of its foreign currency mortgage portfolio.

An upgrade of Pekao is unlikely, and would probably require all of the following conditions to be met: (i) a further strengthening of the bank's standalone profile (which is unlikely in the short term given weakening profitability); (ii) a sovereign upgrade; and (iii) a revision of the Outlook on Unicredit to Stable, with its rating remaining at least at 'BBB+'.

PBH's IDRs are likely to move in tandem with those of Pekao.

The rating actions are as follows:

Pekao
Long-term IDR: affirmed at 'A-', Outlook Stable
Short-term IDR: affirmed at 'F2'
Viability Rating: affirmed at 'a-'
Support Rating: affirmed at '2'

PBH
Long-term IDR: affirmed at 'A-', Outlook Stable
Short-term IDR: affirmed at 'F2'
Support Rating: affirmed at '1'
National Long-term rating: affirmed at 'AA(pol)', Outlook Stable
National Short-term rating: affirmed at 'F1+(pol)'