A foreclosure law signed by Romania’s president yesterday (Thursday) that gives borrowers the right to strategic default will have a negative impact on potential covered bond issuance, according to a market participant and Moody’s, but the exemption of certain loans is expected to lessen the blow.

Romanian president Klaus Iohannis yesterday promulgated a mortgage foreclosure law that affords most Romanian mortgage borrowers the option of a strategic default, giving them the right to pay off their mortgage loan by transferring ownership over the mortgaged property to the lender. Subsequently, the lender would no longer be able to ask for any additional payments.

The law, which was approved by Romania’s parliament on 13 April, applies to existing and future mortgage loans.

In a comment published on Monday of last week (18 April), Moody’s said the law is credit negative for Romanian banks because it will result in more defaults and lower recovery rates on mortgages.

The rating agency noted that mortgage-backed loans, which include mortgages and mortgage-backed consumer loans, constituted 24.6% of Romanian banks’ total loans as of January 2016, and estimated that BRD, Raiffeisen Bank SA and Banca Comercială Română would be the most affected.

When the mortgage law was first proposed last year, market participants close to the matter said it could have a negative impact on prospective covered bond issuance from Romania, as it would hit lenders’ recourse to borrowers.

The law was revised since the first draft, with mortgage loans of a value of more than Eu250,000 and mortgages provided under “Prima Casa” (First House), a state subsidy programme, made exempt.

Raluca Nicolescu, director of balance sheet and portfolio management at Raiffeisen Bank SA, said the law will delay Romanian issuance, but said the impact will be mitigated by the exclusion of Prima Casa loans.

“The law will affect cover bond issuance, as it affects the loans in the pool – their current features as well as would-be mortgage product in the market,” said Nicolescu. “Yet, the law excludes the First House loans, the dominant product originated by banks in recent years, with a significant weight in the balance sheet of some large players.”

Moody’s analysts noted that mortgages provided under the Prima Casa programme constituted 35% of all mortgage-backed loans in Romania as of June 2015.

“From our perspective, this debt-discharge law as it is outlined is credit negative for covered bonds,” said Alexander Zeidler, senior analyst at Moody’s. “However, we will need to observe the actual severity of the impact on covered bonds.”

Zeidler said the impact of the law will depend on the extent to which mortgage borrowers use the law, and noted that cover pools may contain mortgage loans originated under the Prima Casa programme, which are exempt.

The promulgation of the new mortgage law comes shortly after Romania’s long-awaited revised covered bond legislation came into effect on 3 March, with related secondary regulations implemented on 11 March.

In a sector comment on 15 April, Moody’s said the law gives the cover pool administrator a range of options for reducing financing risk, which it said is credit positive. However, it said that asset coverage requirements in the framework include both credit positive and credit negative provisions.

Changes to Romania’s Mortgage Bond Law of 2006 were proposed by the Ministry of Finance in April 2014 with the aim of opening up the market for covered bonds in the country.