Moody’s says UK Mortgage Relief Plan May Hurt RMBS
Moody’s Investors Service says there may be liquidity and credit implications for UK residential mortgage-backed securities (RMBS) transactions following the UK Government’s decision to underwrite certain deferred mortgage interest payments for up to two years.
The basic tenets of the proposal will allow households that experience a significant and temporary loss of income to defer a proportion of their mortgage interest payments for up to two years. The Government will guarantee the deferred interest payments in return for banks’ participation in the scheme. The deferred interest will be rolled up and added to the outstanding mortgage balance. At the end of the deferral period the borrower will resume affordable monthly payments by extending the term of the mortgage.
Moody’s says there are several potentially positive outcomes from this scheme, such as helping borrowers who face temporary income shortfalls to reduce their financial burden for up to two years, allowing them to resume these obligations once their financial circumstances improve. As well as reducing the overall number of foreclosures this may postpone foreclosure in the hope that the economic environment generally, and the housing market specifically, improves.
However there are also possible negative implications, particularly for RMBS transactions.
The scheme may lead to liquidity shortfalls in some transactions by effectively increasing the amounts of delinquent loans.
Eligible borrowers may cease all payments whereas previously they may have been able to maintain at least some or all of their payments. Additionally the economic environment, and crucially house prices, may fail to improve or even worsen resulting in a lower recovery value and thereby increasing the ultimate credit loss to the transaction.
If a significant number of eligible borrowers in a transaction choose to exercise this option, and they are reported as delinquent, delinquency triggers might be breached earlier. Some of the consequences of a trigger breach in UK RMBS include the prevention of future substitutions, further advances, loan conversions and reserve fund amortisation and typically result in sequential allocation of cash flows in the transaction. Generally such triggers are in place to benefit noteholders, meaning an earlier breach could be positive for the transaction. However, reporting such borrowers as being current could artificially delay trigger breach and therefore negatively impact noteholders.
Furthermore, it is common for UK RMBS transactions to have restrictions on loan modifications and in particular term extensions which, if breached, would require the seller to re-purchase the loan out of the RMBS pool, Moody’s concludes.
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