The Italian government is proposing a new decree that allows for loan modifications. This change is aimed at making mortgage debt more affordable for certain borrowers, resembling recent U.S. government loan modification initiatives.
It is also the first government-led proposal of its kind seen in Europe.
The new law will allow borrowers to lower mortgage installments on existing mortgage loans, while extending the maturity of their mortgages, triggering changes in Italian mortgage regulations.
A first draft framework on "mortgage renegotiation" has already been approved by the Associazione Bancaria Italiana (ABI). Final details have to be agreed upon within the next 30 days.
Under the current draft, variable mortgages for the first home originated before January 1, 2007 can be switched to fixed-rate. The rate change is effective 90 days from the day of renegotiation. Regulators also propose that banks be obliged to renegotiate mortgages. The new law proposal effectively allows borrowers to stabilize and reduce future installments since the new installments will be calculated by applying the average mortgage rate in 2006.
The changes will not imply a decline of the debt amount owed to the bank, but they are likely to generate an increase of the mortgage's term. Further, the difference between the prior mortgage arrangement and the new one will be recorded on a separate account at a 10-year interest rate swap plus a spread of 0.5%, which has to be paid by the borrower. However, under the new proposal, the borrowers will not have to provide any further guarantees if they change their mortgage terms.
The new measures follow recent changes included in the Bersani Decree where prepayment penalties on certain mortgages were eliminated and led to the highest rate of prepayments seen in the Italian market since 2000, according to Standard & Poor's.
"Overall, this new decree has the potential to lower prepayments but negatively influence mortgage maturity and excess spread levels," said UniCredit Markets & Investment Banking analysts. "But maybe a renegotiation of mortgage terms could also be treated as a prepayment in Italian RMBS going forward? Uncertainty remains until further details are revealed."
The initial concern among industry players is that the new changes proposed under this current decree could adversely affect Italian RMBS performance. Fitch Ratings said that the proposed renegotiations might negatively impact the maturity of the underlying mortgages and the level of spread generated by the portfolio because it allows borrowers to lower the mortgage installment amount and keep it constant over time, despite further increases of interest rates. It also allows borrowers to extend the maturity of the loans until full repayment of the outstanding debt.
Unicredit analysts said that if increasing interest rates increase under the terms set out by the new decree, excess spread available could be exhausted considerably. The underlying mortgages might be extended, which will influence the legal final maturity of the notes. Currently, more than 50% of outstanding Italian mortgage products are floating-rate loans. Under the current interest rate scenario, mortgage borrowers' affordability has been threatened, which has already led to increasing loan repayments. ABI estimated that the new law proposal might affect 1.25 million households.
"The uncertain application of this law will no doubt cause further confusion for Italian RMBS holders and potential buyers," Societe Generale analysts said. "The loan extensions are not likely to be significantly negative from a credit standpoint. However, negative amortization would increase the losses on an already slow repossession process and could cause credit enhancement to reduce over time.
"Existing transactions could require increased liquidity facilities or hard credit enhancement to hold current ratings," SocGen analysts said. They expect parties active in securitization will lobby the government for a workable solution for RMBS transactions.
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