The mortgage loan modification scheme launched on Dec. 18 by the Italian Banking Association (ABI) could have a negative impact on Italian RMBS ratings if issuers implement it without correcting for potential distortions which could affect standard RMBS structural features, said Fitch Ratings.
The scheme consists of a 12-month mortgage loan payment holiday, either on principal payments only or principal and interest payments, for financially distressed borrowers that satisfy certain eligibility criteria. If a mortgage loan is in arrears at the start of the payment holiday, the arrears period is counted as part of the 12-month payment holiday.
Delinquent and defaulted loan statistics are used in Italian RMBS to regulate a series of structural features. Fitch takes these features into account in its rating analysis of Italian RMBS and they are considered, in some instances, as crucial for the rating performance of such notes, including the excess-spread provisioning mechanism to cover for defaulted loans.
If the new scheme is implemented by an RMBS issuer, borrowers entering the payment holiday would theoretically be classified as performing, as they would "freeze" their arrears status until the end of the payment holiday window.
Italian RMBS loans are normally classified as delinquent or in default, for the purpose of the transaction, depending on the number of installments in arrears.
If an RMBS issuer implements the scheme, without adjusting the delinquent and defaulted loan definitions to take payment holidays into account, the loan modification scheme could result in a weakening of the transaction's structural features and potentially have a negative impact on note ratings.
In addition, the payment holiday scheme could impact the swap payments of certain transactions, resulting in a potential weakening of swap coverage and/or a change in swap payments. This in turn could result in an issuer's swap counterparty requesting a termination of the swap agreement.
As the borrowers benefiting from the payment holiday are distressed borrowers, Fitch would expect RMBS issuers that implement the scheme to improve their portfolio reporting and to provide enhanced disclosure about the number of loans which are subject to a payment holiday.
Such additional reporting would enable the agency to adequately assess the quality of the pool and whether the payment holiday had resulted in a distortion of pool performance.