Recent amendments to Spain’s legal framework for mortgage loans weaken creditors’ recourse to low income borrowers, but preserve full recourse mechanisms in the Spanish market, according to Fitch and Moody’s.

Spain’s parliament passed a resolution, Royal Decree 8/2011, on 30 June that, among other changes, increases the threshold of defaulted borrower income that is ring-fenced from a claiming creditor. The new law became effective on 7 July, and was put forward by the ruling Socialist party, the main opposition People’s Party and Catalan group Convergencia i Union, demonstrating widespread support for the move.

Alvaro Gil, director, covered bonds at Fitch, said that a motivation behind initiatives to end or modify full recourse was the large number of legal cases for repossessions since 2008. There have also been recent protests in support of borrowers facing repossession.

According to statistics from the Spanish judicial system cited by Moody’s, the number of foreclosures reached 93,000 in 2010, up 260% from 2007 levels. Fitch said that legal cases for repossessions since 2008 totalled 240,000.

Under Spanish law mortgage borrowers remain personally liable for their debt after foreclosure, instead of being able, as is the case in some countries, to discharge that debt in bankruptcy.

Carlos Masip, director, RMBS at Fitch, said that payment in kind in Spain is traditionally 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,” he added.

Fitch said that although newly approved changes to Spain’s mortgage loan framework may reduce the strength of full recourse from a cashflow perspective, in particular for low income borrowers in negative equity situations, it continues to consider the Spanish debt market as one featuring full recourse.

“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,” it said.

Such disincentives include the alternative costs of occupancy such as property rental or the potential loss of fiscal benefits, according to Fitch.

“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,” it said.

In Fitch’s view the new law could trigger a tightening effect on mortgage underwriting policies, in particular with regards to loan-to-value ratios for low income borrowers.

More income protected but unemployment key

Moody’s said that the revised framework introduces three main changes. A first involves raising the threshold that full recourse to a defaulted borrower’s existing and future income is applicable to, a change that Moody’s described as “curtailing the rights of creditors to attach the wages of borrowers who default on their mortgage loans”.

Until recently a creditor was allowed (following a court decision) to garnish a defaulting borrower’s wages, but only those above 110% of the national minimum wage. The amendment raises the floor to 150% (around Eu961), according to Moody’s.

It said that this measure will have a negligible impact on the Spanish RMBS market because most of a mortgage loan’s recovery stems from the effective sale of a property, and not from the personal liability remaining against a mortgage borrower if the foreclosure process ends with any debt outstanding.

“Full recourse to the borrower remains unchanged, so incentives to repay are still in force,” said Moody’s. “[U]p to now the Spanish banks have seldom exercised this right on mortgage loans assigned to RMBS transactions.”

The rating agency also said that personal liabilities have a very minor impact on the recovery amount of mortgage loans, in particular when the main driver of the default is unemployment; this stands at around 20%.

The new framework also raises the minimum percentage of the property value – from 50% to 60% – at which a bank can repossess a mortgaged property if the foreclosure process ends with no offers.

Carlos Terre, director, structured credit at Fitch, said that from an equity standpoint the reduction of the haircut from 50% to 40% will shift potential losses from the obligors’ side to the banks’ side, but that the rating agency considers the effect on recovery assumptions to be neutral.

Moody’s highlighted a third amendment, which reduces the amount that a party has to deposit upfront to participate at a property auction.

“Lowering the liquidity requirement may attract more bidders; the third amendment may thus be considered credit-positive, so long as it forms an incentive for third parties to bid at mortgage auctions,” said Moody’s.

Overall, however, Moody’s said that the amendments will have a very limited, if any, effect on Spanish RMBS deals.

Source: Plataforma Afectados por la Hipoteca