Spain’s ministry for economy and competitiveness on Wednesday proposed mortgage law reforms that bank and rating analysts said could have negative implications for the Spanish covered bond market, although there are some positives.

Luis de Guindos, Spain's Minister of Economy and Competitiveness

The package of reforms is aimed at tackling the problem of mortgage defaults and includes capping to 30 years the amortisation period of housing loans eligible for cédulas hipotecarias and easing criteria for a debt for asset swap for mortgagors.

Jose de Leon, Moody’s senior vice president, senior credit officer, said that the proposal to cap the duration of mortgages eligible for cover pools could improve the credit quality of cédulas in the long run as it would reduce the risk of mortgages running beyond the retirement age of the borrowers, and the default risk related to borrowers’ mortality.

However, it could have unintended consequences in the short term, especially if the restriction is applied to existing mortgage books.

“There is uncertainty about whether the law would have a retroactive effect,” he said, “but if it did overcollateralisation could fall dramatically overnight, as mortgages above 30 years constitute 10% of the Spanish mortgage market.”

Another implication is that the measure could increase uncertainty in the cédulas market and thereby have an impact on investor confidence.

“It would be changing the rules of the game while playing the game,” he said. “This could hinder the flow of funding to refinance Spanish mortgages.”

A covered bond banker said that government intervention questions one of the core identities of the covered bond market, namely that it is generally limited to assets of public policy.

“This is a positive as all over the world governments support public sector and mortgage assets in more or less explicit ways,” he said. “But also a potential weakness in a societal stress scenario, as they are the assets that politicians are most likely to provide support for, to the potential detriment of covered bond holders.”

Another measure mentioned in the mortgage law proposal is a relaxation in criteria borrowers must meet to be able to benefit from a code of best practice applied by most banks in Spain. According to RBS analysts this allows borrowers to renegotiate the terms of their mortgage loan, either via restructuring or “dación de pago”, ultimately a debt for asset swap.

The analysts said that an increase in debt for asset swaps would be credit negative for cédulas hipotecarias holders relative to senior unsecured investors since a directly owned property, as opposed to mortgage loans, is not part of the cover pool.

De Leon said that this measure could have a negative impact in the medium term as it would weaken the full recourse of cédulas, especially in light of the trend of falling housing prices in Spain.

According to figures published by the Spain’s National Institute of Statistics, in the third quarter of 2012 housing prices fell by 15.2% year-on-year on average.

Moody’s de Leon said that the reform proposal package is vague, but that the government is committed to tackling social problems related to the increasing trend of defaults on mortgage repayment and home evictions. The government benefits from a parliamentarian majority, so if it intended to proceed with the reforms there would be a high chance of them being implemented, he added.