Moody's expects debt forgiveness - rather than repossession - to become the preferred option for lenders dealing with borrowers that have unsustainable mortgage debt, once all other alternatives have been deemed inappropriate or unsuitable.
Long term, the legislation provides an efficient mechanism to deal with the current mortgage arrears and negative equity issue.
Moody's says that resolving this issue will help expedite the recovery and strengthening of Irish banks' balance sheets, which would be a long-term credit positive for banks and their covered bonds.
However, in the short to medium term, the rating agency expects that the legislation will increase arrears and losses on existing mortgage loans, which is a credit negative for RMBS, banks and covered bonds.
OPPORTUNITY
The key element of the new legislation relates to residential mortgage loans.
Borrowers who are certified as cash flow insolvent, as described below, could be eligible to enter into a Personal Insolvency Arrangement with their creditors.
If at least 50% of secured creditors and 65% of total creditors agree, the PIA could reduce the mortgage down to the relevant property's current market value and the borrower would continue to live in the property.
Moody's notes that house prices have dropped by 50% from their peak 2007 level (according to Central Statistics Office, Ireland), leaving over half of Irish residential mortgage loans in negative equity.
In two special reports published earlier this year, Moody's commented that without tight controls in place, especially around the measurement of cash flow insolvency, the scale of the negative equity issue in Ireland could cause substantial write-offs under the new legislation.
SHORT-TERM
In the short to medium term, the introduction of the new legislation will lead to an increase in arrears and losses.
Under current Irish Law, a borrower defaulting on their mortgage loan could lose their home, but also remain liable for the full outstanding debt for at least 12 years.
These 'full recourse' arrangements provide a strong incentive for financially distressed borrowers to meet their mortgage loan repayments.
However, the new legislation poses the risk of moral hazard because it reduces borrowers' incentive to repay. Moody's believes that the credit-negative implications of an increase in arrears and losses will be most acute for RMBS pools, since those pools will not experience the long-term benefits available to banks and their covered bonds.
LONG TERM BENEFITS
In the long term, the legislation will help resolve the current mortgage arrears and negative equity issue and therefore quicken the recovery and strengthening of Irish banks' balance sheets. All of the rated Irish banks have been recipients of substantial capital support from either the Irish government or, in the case of foreign-owned banks, their parents. Moody's therefore considers that the banks will be able to cope with substantial losses from their mortgage books.
For covered bonds specifically, the mechanics of the Irish Asset Covered Securities (ACS) Act and standard practice by the issuers imply that investors should be insulated from any rise in arrears until the point of a potential issuer default.
The ACS act does not permit mortgage loans that are more than three consecutive payment dates in arrears to be included in the cover pool. In practice, the issuers have so far not added to the cover pools any loans in arrears and have actually removed mortgage loans that have become delinquent.
DEBT FORGIVENESS
An independent third party, yet to be established, will assess a borrower's eligibility for a PIA.
At present, the precise details are unclear, but the basic criteria requires the borrower to be unable to pay their debts when due and be expected to continue in this position for the next five years.
Other alternative restructurings must also have been considered and viewed as ineffective to restore the borrower's solvency. Thus far, banks have shown limited appetite to enforce security due to political pressure and alternatives to repossession have been sought because of the costs involved in the current process.
The bill was published on 29 June and is expected to come into force in 2013.
