The FINANCIAL — Madrid/London-18 July 2011: Fitch Ratings says that although a newly approved law in Spain partially reduces the strength of full recourse, the agency still considers the Spanish debt market as a full recourse one.
While Fitch views the effect the new law will have on recovery rate assumptions as neutral for mortgage loans to individuals, the agency believes it may reduce the strength of the full recourse from a cash flow perspective, especially for low income borrowers in negative equity situations. However, the change will have no immediate impact on ratings.
Earlier this month, the Spanish government approved a Royal Decree (8/2011) which raised the threshold that full recourse to a defaulted borrower's existing and future income is applicable to EUR961 from EUR642 per month, and an additional EUR193 per each family member with no income or with an income below the minimum salary. The Royal Decree also increased the legal minimum price allowed for repossession by the lender at auction to 60% from 50% of the initial valuation amount when the auction has no bidders. The modification only applies to the borrower's first residence.
"Traditionally, payment in kind in Spain is only possible with the lender's agreement. Full recourse to current and future assets and income of the obligor is systematically used by banks to ensure full recovery on defaulted mortgages when the foreclosed property value at auction does not cover the outstanding debt," says Carlos Masip, Director in Fitch's RMBS team in Madrid.
"There have been a number of recent initiatives pushing for a legislative change to end or modify full recourse. These were motivated by the large number of legal cases for repossessions since 2008, which totalled around 240,000, according to the Spanish Judicial System's statistics," says Alvaro Gil, Director in Fitch's Covered Bonds team in Madrid.
Fitch believes the new law could affect a borrower's willingness to pay under a delinquent loan and consequently encourage default, mainly for those low income borrowers with stretched affordability that are perceived to be underwater, (ie. that have a mortgage loan outstanding above the current or expected property value).
"From an equity standpoint, the reduction of the haircut to 40% from 50% for lenders to repossess the property when there are no bidders at auction will shift potential losses from the obligors' side to the banks' side," says Carlos Terre, Director in the Structured Credit team in Madrid. The agency views the effect on recovery assumptions as neutral, since Fitch does not account for proceeds other than the sale of the property in an open market when estimating the recovery rate.
From a cash flow perspective, the most affected loans will be those granted at the peak of the market to lower income borrowers (i.e. so the minimum salary increase covers a large proportion of the family income and therefore is incentivised to "turn over the keys"). While Fitch acknowledges this reduces the strength of the full recourse, the agency considers that the increased income threshold is not sufficient to encourage default given the alternative costs of occupancy such as property rental or the potential loss of fiscal benefits.
Fitch recognises that there are many disincentives that a sensible borrower will consider before defaulting on its mortgage loan to take advantage of the newly-approved measures. The full recourse mechanism over borrower's existing and future assets persists by law, and would disqualify defaulted borrowers from owning other assets or from generating additional income in the future.
Fitch anticipates this new law could possibly trigger a tightening effect on mortgage underwriting policies and in particular with regards to loan-to-value (LTV) ratios for low income borrowers. If such tightening materialises, lower prepayment rates can be expected for existing mortgages with these characteristics over the next months.
While this change in itself will not result in a change to Fitch's Spanish RMBS criteria assumptions, the agency will request additional data to identify buckets of potential borrowers affected by the new law and will monitor the situation on an ongoing basis to identify potential trends.
Discussion about this post