An extension of relief for borrowers with foreign currency mortgage loans passed by Hungary’s parliament last Tuesday is credit negative for covered bonds as it will reduce the value of cover assets if issuers do not add assets to compensate, according to Moody’s, which also highlighted the issue of moral hazard.

Moody’s rates the covered bond programme of OTP Mortgage Bank (Jelzalogbank) Baa3 and those of FHB Mortgage Bank, Ba3.

The law extends an existing programme to delinquent non-Hungarian forint-denominated mortgage holders and borrowers with non-forint-denominate mortgages of more than HUF200m (Eu67,000), said Moody’s. The rating agency quoted figures from a Hungarian central bank financial stability report this month showing that 42% of foreign exchange borrowers have taken advantage of the current scheme and Moody’s said the Hungarian government estimates that two-thirds of remaining foreign currency-denominated loans will now be eligible.

Eligible borrowers will be able to restructure their mortgages at a discounted exchange rate. For example, a borrower with a Swiss franc mortgage can repay this at a rate of 180 Swiss franc/forint, which is a 25% discount to Friday’s spot rate.

The difference between the discounted and spot rates is converted into a forint loan repayable at the end of the mortgage’s term. The government offers a first loss guarantee on this and pays half the interest, with banks forgoing the remainder of the interest – and hence this no longer being available to covered bondholders after an issuer insolvency, noted Moody’s.

“The government will only extend the guarantee if the bank is willing to waive a portion of the loan so that the remaining loan does not exceed 95% of the value of the mortgage collateral,” it said. “Up to 20% of the cover assets in covered bonds that we rate have loan-to-value ratios exceeding 95%. Waiving the debt is not obligatory for the banks, but non-participating banks lose the government’s first loss guarantee on the difference between exchange rates.

“Consequently, banks need to weigh potential losses on loans already in arrears with losses on waived debt. A debt waiver will lead to an instant reduction of the amount of cover pool assets if covered bond issuers do not compensate for that.”

Moody’s said the law will also decrease partial asset-liability hedges in the programmes it rates, particularly that of OTP, which has HUF505bn equivalent of euro covered bonds outstanding – or almost 50% of its issuance – against HUF441bn of mainly Swiss franc and also euro denominated mortgages as collateral, the latter comprising 33% of the cover pool. Foreign currency mortgages comprise 41% of FHB’s cover pool but euro denominated debt comprises only 15% of its covered bonds.

“This is likely to have negative consequences if the bank supporting the programme defaults,” said the rating agency.

Moody’s said the law will also reinforce moral hazard for borrowers in foreign currency.

“The foreign exchange borrower-relief scheme exacerbates uncertainty about future legal developments and reinforces moral hazard for borrowers with foreign exchange-denominated debt,” it said. “The relief scheme could indicate to borrowers that banks might waive their foreign-exchange denominated debt if they fail to meet their payment obligation.

“A central bank and [market research firm] GfK survey indicates that 25% of the borrowers who have not yet participated in the debt relief scheme are waiting for a more favourable borrower relief programme.”