Like their peers elsewhere, Spanish mortgage originators are staggering through a tough year, but the economic headwinds they face are especially daunting.

Yet delinquencies, while up, are still far from alarming. For now, participants are concentrating on where the weaknesses are, and whether they will, down the road, lead to more serious problems.

Due for a nasty hangover after years of explosive growth, the country's real estate market has started to sink. Housing sales tanked 32% from the first quarter of 2008, according to Spain's Housing Ministry.

More importantly, the leading index for housing prices posted a 4% year-on-year increase for the first quarter. But with inflation running at 4.7% in May, the real figure is probably already in the red. Forecasts point to a further deterioration.

Other related figures also augur ill for the Spanish homeowner. Consumption is reeling from a combination of escalating inflation and a cratered construction industry. Retail sales fell an annualized 3.4% in real terms during May. Societe Generale last month forecast a drop in consumption for the second quarter.

Effect on RMBS

Whether all this will filter insidiously into outstanding RMBS for the most part remains to be seen. Among players, discomfort is highest among recent vintages. "There was a relaxation of criteria in 2007 and late 2006," said Barbara Rismondo, a senior analyst of RMBS monitoring at Moody's Investors Service.

Overall, delinquencies of 60+ days among Spanish RMBS rated by Moody's hit 1.13% in the first quarter of 2008 from 0.56% a year earlier. While an inarguably steep increase, the base was quite low. The agency's delinquency index showed that the 2007 vintage, and to a lesser extent the 2006 one, have exhibited higher delinquencies than other vintages just a year or two out of the gate.

The secondary market has been pricing in the perception that the younger deals are weaker, even though relatively subdued trading in Spanish RMBS could be overstating the difference, said one London trader. "The concern is that the more recent Spanish deals have high LTVs and that the collateral might be weaker," he added.

Weak collateral performance has led to only one Moody's downgrade over the last year. In April, the agency cut the Class C, D and E notes of Madrid RMBS II FTA, originated by Caja Madrid. At the same time, Moody's affirmed the Class A1, A2, A3 (Aaa) and B notes (Aa1).

"The rating actions have been prompted by worse-than-expected collateral performance leading to above-market average delinquencies," the agency said in a report.

Cumulative defaults equaled 1.06% of the original loan balance, while the 90+ day delinquencies reached 1.74% of the current pool balance. In addition, there wasn't enough excess spread to replenish the reserve fund to the required level for the last three interest payments.

Higher interest rates are also troubling for outstanding transactions, as the vast majority of mortgages, and consequently RMBS, are floating-rate. The jump in the Euribor is leading to a jump in mortgage payments by Spanish borrowers.

It has also led to reserve draws in deals, since there is a lag between the index that serves as the benchmark for mortgage payments and the Euribor that deals are priced off, said Jean-David Cirotteau, lead ABS analyst at Societe Generale. "This is what created shortfalls between payments and the coupons," he added. In the first quarter, Madrid RMBS II, TDA 15 Mixto and TDA 22 Mixto all had drawn on their reserve funds.

LTVs Under the Microscope

As LTVs are a main driver of performance, payers are closely monitoring the drop in prices. This indicator's importance is underlined by changes in approach that Moody's has implemented. "We have increased our default frequency curve by LTV and new adjustments were included to take into account new loan characteristics," said Maria Turbica, associate analyst of RMBS monitoring at Moody's. "Depending on loan-by-loan data, this will have different impacts on credit enhancement levels."

The issue of LTVs - and where the indicator is most vulnerable - is leading some to look into the geographic distribution of housing weakness. As in the U.S., the housing boom was headier in some areas than others. The downturn could be similarly uneven. While there's been speculation that the coastal regions are most vulnerable, this may not be meaningful for RMBS.

"Some of the coastal regions had a behavior in housing prices that was different from the average," said Cirotteau. "This could be something to consider within a transaction. [But] I'm not sure that if you made an econometric study you'd come up with something significant."

Indeed, a number of the pools are multi-originator. As a result, even if an originator or two tend to have geographically concentrated pools, the presence of loans from others will spread the risk. In addition, there have already been instances of deal programs weakening after the pool branched out of coastal regions. "Concentration in the regions of Valencia and Murcia for Bancaja series has diminished following expansion to other areas, and delinquencies have [still] increased for recent vintages," said Moody's Turbica.

Differentiation could potentially take hold on another front. There are two main types of originators behind Spanish RMBS: commercial banks and savings banks known as cajas. In general, mortgage delinquencies have been higher in the latter group.

"My concern is that savings banks are much more concentrated on the mortgage lending - this is what has driven their growth in the past years," said SocGen's Cirotteau. A trader said that the market was currently more concerned with the seasoning of the deals than the type of originators, but he didn't discount that down the road other factors could play a larger role in secondary prices.

As originators deal with higher delinquencies, Cirotteau said the smaller cajas will see their servicing put to the test. But Moody's doesn't see reason for concern in relation to servicing, said Senior Associate Ignacio Rivela. Servicer risk is somewhat tempered by a gestora, which in each deal is responsible for keeping an eye on the servicer, but doesn't perform servicing functions itself.

While delinquencies have risen, it would take a fairly severe housing recession to imperil the senior tranches of Spanish RMBS, Standard & Poor's said in a recent report. Even in scenarios in which BBB' tranches would default, significant downgrades of AAA' notes are unlikely, the agency added.

Some Issuance

With all the challenges dogging Spanish originators, it's surprising they've continued to issue RMBS this year at a healthy clip. Some 19 RMBS have been floated for about 25 billion ($39 million) this year. While the number is a drop of about 19% from the first half of 2007, by any standards it's a respectable figure, especially considering that Spain was a motor of European RMBS growth in recent years. But the mere fact of issuance doesn't tell the whole story. It's no secret that the deals haven't been going to market.

Originators have been structuring paper for the European Central Bank's (ECB) repo collateral (ASR, 6/12/08). While they've been avid users of the repo window lately, compared with European counterparts, Spanish banks are apparently still below their prorata share as measured by balance sheet. But funding problems could arise if the ECB tightens access.

At any rate, a sharper slowdown in issuance seems inevitable. The rate of origination growth is plunging fast. The latest figures from Spain's national statistics bureau show that housing mortgage origination suffered a 42% freefall in March from a year ago, with only 9.9 billion in loans generated.

Even a smaller RMBS output will have trouble finding buyers. In an effort to pry open a new source of funding for securities, Spanish savings banks have floated a proposal to allow a deposit guarantee fund to invest in fixed-income debt instruments. The fund is financed by the Bank of Spain and premiums by the banks. The government would need to approve the change. It remains to be seen if such a political move will fly given the public's sour view of securitization.

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

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