The Spanish government announced the launch of a mortgage deferral measure to aid unemployed, old-age pensioners and self-employed borrowers struggling to pay their mortgages. Although the move could potentially bailout a significant number of struggling homeowners, there could be a potential downside for existing Spanish RMBS deals.

"If we assume that the reported government estimates of 500,000 borrowers end up using the scheme and they all defer the maximum >500 ($625) a month from day one, the total guaranteed deferred payments would amount to >6 billion or some 2.2% of Spanish GDP over two years," Deutsche Bank analysts said.

The measure would directly benefit borrowers who have taken out a mortgage of less than >170,000 on their primary residence before the beginning of September 2008, and who are currently facing repayment.

Under the deferral, the obligor would pay just half of each scheduled installment for two years, reduced up to a maximum of >500 a month. The Spanish government will guarantee the postponed partial mortgage payments through its financial agency Instituto de Credito Oficial (ICO), though it's not yet clear how this guarantee will function and when guaranteed missed payments will be applied.

Once the moratorium elapses, installments return to the initially scheduled amount and borrowers could face a potential payment shock once repayment of the deferred payments kicks in. Deutsche analysts estimated that a borrower who elected to defer the maximum >500 per month over the full two-year period would end up having to pay an extra >100 a month for 10 years, following the expiration of the two-year holiday from regular payments. Fitch Ratings said that the measures could essentially serve as a delay in the foreclosure process on loans whose borrowers may ultimately not have the ability to repay once the two-year period has elapsed.

The moratorium could also create liquidity stresses by reducing the excess spread on non-guaranteed existing transactions, which could impact Spanish RMBS ratings. A number of structures have guaranteed excess spreads in their embedded swap agreements, so the measure would not affect them.

However, Deutsche Bank reported that approximately 50% of mortgage pools in the benchmark deals it tracks would meet the maximum mortgage size criteria and therefore become eligible for modification. The moratorium on payments would create a liquidity stress in these deals by reducing the level of excess spread and amortization payments generated by the portfolios. Although Spanish RMBS contracts require that originators make whole either through asset replacement or by other means, it is unclear whether government would rule out the deals' contractual language and allow loan modifications that are detrimental to the transactions' current cash flows.

"We would expect the recent proposal to benefit credit performance in the near term, but at the expense of cash flow extension as some loans enter payment holidays," said Jean David Cirotteau, a Societe Generale analyst. "While the government would compensate the securitization fund directly under the terms of its guarantee should modified loans ultimately default, associated loss severities may be higher post the deferral period under a scenario of prolonged house price falls," he said.

Investors should check whether the excess spread is guaranteed under the swap, and what portion of loans are potentially affected, according to Cirotteau.

Cedulas hipotecarias, or Spanish covered bonds, could also be impacted by the new relief measure, as loans made to the target group would likely continue to be part of the cover pool. Fitch said that the postponement of mortgage payments could impact the timing of expected cash flows from the portfolio. Such flows are modeled by the agency in its covered bond analysis.

But the forced restructuring would also help obligors to withstand the crisis by minimizing pool defaults and allowing borrowers the time to improve their financial conditions and thus resume paying their full mortgage obligations over the longer term. Fitch analysts said that loans that benefit from the proposed partial moratorium may be required to be repurchased from RMBS mortgage pools, as a result of a breach of representations and warranties on existing deals, which would result in increasing prepayments.

"As far as we know, mortgage literature on restructuring instead of pushing impaired borrowers to foreclosure shows this is highly beneficial and inevitably more financially efficient than repossession," Cirotteau said. The details of this Royal Decree have not yet been published, but are expected to be soon.

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

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