Primary residence report positive, Fitch says

Reforms to the system whereby financially weak Greek households can try to restructure their debts are positive for banks and Greek structured finance (SF) and covered bond (CVB) transactions, Fitch Ratings said.

The credit rating agency said that these reforms should provide a more effective mechanism to work out the most problematic non-performing loans (NPLs), restrict strategic defaults and potentially lead to a more disciplined payment culture. The full impact will depend on implementation details and how the new framework is used.

“The updated primary residence protection law that was passed at the end of March replaces the Katseli law, which had protected delinquent borrowers’ primary residences from repossession,” Fitch said in the report.

“Under the new framework, borrowers who were already more than three months in arrears on 31 December 2018 can apply online to restructure housing and business loans secured on their primary residence. Applications can be made until the end of 2019. The end-2018 cut-off point, the temporary nature of the scheme, and narrower eligibility criteria for protection from repossession than under the Katseli law, all reduce the scope for strategic defaulters to apply for protection,” it added.

“Combined with the threat of foreclosure, this could over time support an improvement in payment discipline. When a restructuring is agreed for borrowers protected by the new law, debt write-offs and government plans to subsidise re-performing borrowers will boost repayment capacity. If restructuring is not agreed or the borrower ceases to make timely payments on the restructured loan, lenders will be allowed to foreclose. This should incentivise borrowers to agree a restructuring, reduce re-default rates, and support recoveries. If more NPLs are dealt with via the new framework, it will free up resources in the Greek legal system to process repossessions,” the Fitch report said.

The subsidy provision will be enacted via future secondary legislation, and details of its size and any conditionality are not yet available. The European Commission’s second enhanced surveillance report on Greece says it will be applied “in a progressive manner dependent on income” and is estimated at around 30% of restructured monthly instalments, on average.

The Commission reports that haircuts will be mandatory for principal exceeding a loan-to-value ratio of 120%, and the standard duration of restructured loans will be 20 years, but cannot extend beyond a borrower’s 80th birthday. The extension of primary residence protection legislation to business loans secured by borrowers’ homes, which were not covered by the Katseli law, suggests that there could be a rise in the average amounts written off.

The Commission’s report indicates a limited fiscal cost for the subsidy of 150 million euros in 2019 and 200 million euros annually thereafter, although these estimates are uncertain “in view of incomplete data availability”. The eventual costs to banks and the state will depend on the details and take-up of the scheme.

The reform, Fitch said, bolsters its view that the stock of Greek NPLs will fall further in the medium term, supported by policy measures and banks’ efforts to meet their Single Supervisory Mechanism targets. But it is not clear whether banks will aggressively pursue foreclosures to improve recoveries, particularly with borrowers not protected under the new law, as they may be wary of reputational risks, it noted. If banks are perceived to be unwilling to foreclose, this could reduce the effectiveness of the new framework in restoring payment discipline.