The Ukraine's Bank Khreschatyk has issued its first covered bond, a three-year UAH70 million ($14.7 million) trade governed by local law.

Fitch Ratings has given the transaction a 'B+' on the global scale and an 'A(ukr)' on the national scale. The bank's long-term issuer default rating is 'B-'.

Helping to boost the deal two notches higher are an overcollateralization assessed at the legal minimum of 11.1% and the fact that covered bond holders have a preferential claim on the pool of assets.

In a report, Fitch said that the default probabilities of the issuer and the covered bond are the same thanks to an asset-liability mismatch.

"Cash flow mismatches between the amortizing cover asset and the bullet-maturity covered bonds are not compensated for by the availability of liquid assets or by any other mechanism," the agency said.

Dropping liquid assets into the pool in order to plug those gaps is not an option.

"In the current Ukrainian legislation, there is a provision where you can't include liquid assets - such as Treasurys or cash - in the cover pool, as long as sufficient eligible mortgage loans are available to the bank," said Holger Horn, head of covered bonds in Germany at Fitch Ratings. "There are also no other mechanisms in place to compensate for cash flow mismatches between cover assets and covered bonds after an issuer default."

As of Aug. 1, the pool consisted of 403 loans with a total outstanding balance of UAH80.6 million. Residential loans accounted for 86.6% of the pool, with privately owned land securing 9.4% and commercial real estate behind the remaining 4%. The weighted average current LTV was 53.5%. Under Ukrainian law, to be sunk into a cover pool, residential loans must have CLTVs of no more than 75% and commercial loans of no more than 60%.

The transaction is a notch below the Ukrainian country ceiling of 'BB'. To pierce the ceiling, the transaction would need, among other things, some kind of political risk insurance, according to Horn.

Information on the deal's investor base was unavailable as of press time, but it was unlikely that a small illiquid bond in hryvnia would draw much interest in cross-border investors from Western Europe, particularly in the present climate.

While they're denominated in hryvnia, the notes face currency risk as well, since about 40.5% of the mortgages are denominated in U.S. dollars. This is a reversal of the more standard currency mismatch in emerging market securitizations, where the bond is denominated in dollars and the collateral is in local currency.

The deal is not the first covered bond from the Ukraine. That distinction goes to Ukrgazbank, which last year issued a UAH50 million, three-year deal that priced at 10.5%, according to the U.S. Agency for International Development's Web site. The government agency midwifed the transaction through its Access to Credit Initiative program.

The Ukraine is also a relative newcomer to the securitization space, with Privatbank having issued an auto loan deal earlier this year and an RMBS in 2007.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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