Hungarian issuers FHB Mortgage Bank and OTP Jelzálogbank Zrt have said that their covered bond programmes are unlikely to suffer from a Hungarian law allowing foreign currency mortgages to be repaid in forints at a discount of up to 22%.

Moody’s and other analysts raised concerns earlier this week that the law enacted on 19 September could be credit negative for covered bonds and raised the prospect of event risk in Hungarian issues. But the two Hungarian covered bond issuers Moody’s rates said the covered bonds are unlikely to be affected.

“According to the politicians’ estimates about 10% of people will change over,” Máriás György, head of treasury at OTP, told The Covered Bond Report yesterday (Thursday). “That’s why I’m not particularly worried.

“We won’t see any serious direct impact on collateralisation on the outstanding covered bonds,” he added.

The banks said any resulting reduction in the cover pool could be compensated for in two ways.

Within the collateral are mortgage loans and substitute collateral, which comprises cash and/or government bonds. The level of substitute collateral cannot exceed 20%.

“If many borrowers access this law, the necessary substitute collateral can be added to the cover pool,” said György. “OTP’s current level of substitute collateral is almost zero, so it would be a very easy way to improve the overcollateralisation.”

János Szuda, managing director, head of treasury and capital markets at FHB, also said the collateral can be easily supplemented.

“I am not at all concerned,” he said, “because even in the worst case scenario, we can add more collateral.”

FHB has no substitute collateral in its cover pool, but Szuda said it has billions of government paper for liquidity management purposes, which it can easily add to the cover pool.

Repurchasing outstanding covered bonds was the other option for banks, which György and Szuda said was also feasible.

While Szuda was positive covered bonds would not be affected, he acknowledged that Moody’s had a point, in its report, when it said Hungarian legislators may now be pre-disposed to make further changes, with regulatory risk thus heightened.

“It’s the kind of thing that could hurt investor confidence,” he said, “But compare the investor confidence for Greece, Spain, etc, and we’re still doing quite well.”

He added that the covered bonds’ risk profile would be unchanged or could even be improved as there will be a higher share of forints denominated loans in the future as a result of re-mortgaging. He said that of the 10%-20% of foreign currency loans that might be repaid under the law, only 3%-5% were expected to be in cash, with the remainder being remortgaged.

György said the government had communicated that it is committed to resolving Hungarian household problems related to foreign loans and that this move was to demonstrate that.

“It’s the right goal,” he said, “but I don’t know whether this is the right way to do it – intervening in a private legal contract.

“The government just terminated this contract between borrowers and banks, because of this initiative, and now the banks and the banking system are expected to take the losses.”

He said the banks are going to court seeking compensation.

Fitch estimated on Wednesday that the Hungarian banking sector will have to absorb approximately 1.5% of tier one capital as a result of the law, based on a 25% take-up rate. Most banks should be able to sustain the hit to their capital, said the rating agency, but “there are considerable differences in tier one ratios and exposure to foreign currency mortgages between banks, and so some institutions could take larger hits to capital than this aggregate calculation suggests”.

Fitch said the Hungarian authorities’ generally aggressive policy stance on the banking system could make it less likely that parent banks will put more capital and funding into the Hungarian banking system in the future. This could restrict future credit and economic growth.

It “sets a dangerous precedent for other central and eastern European countries with high foreign currency lending”, according to Fitch.

This action will only temporarily provide relief for borrowers, it said, without materially reducing their indebtedness or their foreign currency exposure.