Seven Hungarian banks were placed on review for downgrade by Moody’s yesterday (Tuesday) because of a Hungarian law that gives foreign currency mortgage borrowers the option to repay their loans at a discounted exchange rate.

Two Hungarian covered bond issuers rated by Moody’s, OTP Mortgage Bank (Baa3) and FHB Mortgage Bank (Ba1) , were included in the rating action. The remaining five banks were OTP Bank NyRt, K&H Bank, Budapest Bank, Erste Bank Hungary and MKB Bank.

Moody’s said the law approved on 19 September represented a “sizeable move away from the principles of contract law”.

“This, together with a set of government policy decisions since 2010 that include a punitive banking tax and regulations that still restrict repossessions of collateral on delinquent mortgages, have been adding pressure to lenders and are increasing uncertainty on the likelihood of systemic support for Hungarian banks,” it added.

Foreign denominated loans account for 70% of mortgage lending, said Moody’s, adding that the law will trigger losses for the banks and have an impact on their capital positions.

While the rating agency acknowledges that the potential impact will vary from bank to bank, it estimated that based on a take-up rate of 30%, the conversion at the current market rates would imply a possible loss up to 300bp of the regulatory capital adequacy ratio of the system, which was equal to 13.8% in June 2011.

Though Moody’s allows for a take-up rate of 30%, it notes that the number of borrowers who might take advantage of the option is highly uncertain, because many eligible borrowers may be unable or unwilling to convert their loans because repayments depend on the stretched borrowers’ ability to either mobilise enough cash savings, or to find banks willing to provide refinancing in forints, and the average interest rate on forints-based loans is significantly higher than for foreign currency loans.

The rating agency added that the government scheme “adds stress to a banking system already under significant pressure, reflected by deteriorating asset quality and weak profitability”. It also constrains the banking sector’s capacity to contribute to economic growth.

Moody’s said the review will assess the impact of the law on a bank by bank basis, taking into account the level of exposure to foreign currency mortgages, the take-up rate by borrowers, the level of profitability, and the capital buffers available.

It said the review would also focus on “the likelihood of systemic and parental support for Hungarian banks given the overall weakening support environment”.