Fitch Ratings said that the Greek draft law addressing household debt restructuring is likely to reduce recoveries and increase defaults in pools of Greek residential mortgages and consumer credits, potentially leading to negative rating action.
The proposed law, which is currently under public consultation, seeks to establish a personal bankruptcy framework for private individuals in Greece.
The proposed provisions indemnify eligible borrowers up to 90% of the total amount owed after liquidation of all their assets. This excludes the borrowers’ main residence, where any outstanding mortgage debt could be re-arranged on favorable terms, with debtors remaining liable only for a maximum 85% of the prevailing market value.
As the Greek mortgage market features relatively low LTVs, an 85% loan-to-value (LTV) threshold could prevent losses for the vast majority of mortgage loans, assuming a stable house price environment. However, high-LTV loans are typically more prone to default, the firm said.
"Should Fitch’s expectations for a 15-20% peak-to-trough decline in Greek house prices materialize, then an ever-increasing number of mortgage loans could fall under the scope of the draft law," says Spyros Michas, associate director in Fitch’s structured finance team in London. "In turn, this would increase loss severities, with direct rating implications for underlying Greek securitizations and covered bonds."
For borrowers found to be only temporarily unable to meet their obligations, a payment holiday of up to two years could instead be granted.
The key question is how a court would assess the actual economic status of the applying borrowers, Fitch says, adding that considering the weak tax controls, the extent of undeclared income sources in Greece and the possibility of performing debtors taking advantage of the new favorable regime (moral hazard), the draft law poses significant implementation risk.
Fitch believes the spirit of the new provisions may overall encourage bad payment behavior among Greek borrowers, a trend already evident in worsening loan performance indicators, since the drafts were placed in public consultation in late 2009.
Meanwhile, the introduction of looser credit recording standards in the national credit bureau (Tiresias), primarily by means of reducing adverse data storage timeframes, is likely to exacerbate credit issues.
"Pushing lenders to extend more credit, while undermining their ability to discern credit risk, is a paradox," says Cristina Torrella, Director in Fitch’s Financial Institutions team. "It could inadvertently hinder credit penetration and increase its cost to the economy, as Greek banks strive to protect their balance sheets, scaling back lending and re-pricing risk altogether."
In Fitch’s view, the negative impact of the lenders’ reduced capacity to assess credit risk via Tiresias would more than offset any contemplated benefits from increased liquidity in the economy. At best, the draft law will have no material impact. At worst, it could lead to deterioration in the asset quality of Greek banks, tightening of credit conditions and ultimately contagion to the wider economy.
Following Greece’s sovereign downgrade in December, Fitch placed all Greek structured finance transactions and covered bonds programs on Rating Watch Negative (RWN). While the agency expects to resolve the RWN in the coming weeks, the new law -should it pass in its current form- could exert renewed pressure on the ratings of Greek securitizations and covered bonds.