OREANDA-NEWS. The proposed solution to address the Polish banking sector's foreign-currency (FC) mortgage loans outlined by the country's presidential office on 2 August is a better deal for the banks than previous proposals, says Fitch Ratings. Prior proposals included mandatory conversion of all FC loans at exchange rates favourable to customers, which would have been costly for the banks.

More details on the FC mortgage proposal are expected on 10 August, but initial indications are that in the short term banks will only have to return a portion of the FX spreads they charged customers on FC loans between 2000 and mid-2011. The latest proposal does not completely remove risks related to FC loans because the authorities' goal is to convert these fully into local currency, meaning that banks are still exposed to potential valuation losses. However, the proposal appears to offer banks more flexibility on how they will manage the process.

Our ratings of Polish banks have not factored in risks related to FC mortgage restructuring, as we expected that the solution ultimately adopted would not result in significant one-off losses for lenders. The proposal announced this week appears to be broadly in line with those expectations and so will not result directly in any rating actions. However, some Polish banks' ratings remain under moderate pressure due to reduced profitability and capitalisation and greater uncertainty about the operating environment.

Borrowers who took out FC retail mortgages were forced to service these loans at exchange rates inflated by FX spreads above market rates. The local regulator estimated that, in addition to the potential costs associated with mandatory conversion, returning the full amount of the FX spread under the previous proposal would cost the banking sector between PLN12bn (USD2.8bn) and PLN15bn (EUR3.5bn).

However, the latest proposal is that banks will be able to retain part of the spread and the compensation to customers for the time value of money is also lower under the revised deal. The basis for calculating any compensation payable is also likely to be capped, which will reduce the value of claims to which some customers will be entitled.

The presidential office estimates that banks will have to make payments to customers of PLN3.6bn-4bn (EUR835m-930m). The sector reported net profit of PLN5.3bn for the five months to end-May 2016, which means that this charge appears manageable. Compensation payments will, however, not be evenly spread across banks, with some facing steeper charges than others.

Mandatory conversion of the FC retail loans does not appear to be on the cards, at least in the immediate term. However, the authorities are keen to scale down the level of outstanding FC retail lending and are likely to gradually introduce more punitive risk weights for these loans or introduce additional capital requirements to incentivise voluntary conversion. FC mortgage loans already carry a 100% risk weight in Poland, compared to local-currency mortgages where risk weights are considerably lower. The Polish regulator also applies capital surcharges for FC mortgages at 14 banks, ranging from just below 1% to 3.8% of risk-weighted assets; 75% of the surcharge must be covered by Tier 1 capital.

In our opinion, the new proposals include greater flexibility, which should allow banks to manage the negative impact of conversion on their capital more gradually. And conversion impacts might be partially offset by capital savings arising from lower risk-weights assigned to local-currency mortgages, removal of capital add-ons and some savings on bank taxes arising from a reduction in the tax base. However, if compensation claims prove to be higher than estimated or if the magnitude of additional capital requirements is large and the timeframe for their introduction is tight, some banks might still find they need to raise capital. The authorities intend to monitor conversion rates closely and, in our opinion, forced conversions cannot be ruled out altogether in the longer term.