Moody's: Uptick in Portuguese house prices can curtail losses for covered bonds

In Portugal, increasing house prices limit the credit losses that residential mortgage loans experience in a stressed scenario, says Moody's Investors Service in a sector comment published today.

"House prices increased by 2.2% year-on-year in 2014, at the same time, we don't expect a significant further recovery over the next five years", observes Miguel Lopez Patron, a Moody's Analyst and author of the report.

This is the second year in a row that house prices have risen in the country. A more valuable property backing the same loan amount provides a greater buffer against losses if the borrower defaults.

Moody's doesn't expect a significant recovery in prices over the next five years owing to three persistent conditions. Unemployment, although decreasing, will remain high. Secondly, household debt will also remain relatively high, despite a noticeable decline since 2011. Furthermore, banks will continue to limit residential mortgage lending, in line with their credit deleveraging policy.

Moody's report says stabilising house prices will curb potential increases in existing loan-to-value (LTV) ratios, which in turn will sustain over-collateralisation (OC) levels in covered bond programmes. Under Portugal's covered bond law, only residential mortgage loans with LTV ratios 80% are eligible for inclusion in cover pools. These conditions will help to counterbalance the negative impact on OC sustainability of persistently low mortgage origination and an ongoing slight increase in residential non-performing loans (NPLs).

Lower LTV ratios will help sustain OC levels in Portuguese cover pools. The house price stabilisation and sustained OC levels will reduce the number of loans that are removed from cover pools due to high LTV ratios, i.e., those above the 80% threshold. This environment will help to mitigate the negative effects of banks' mortgage deleveraging activities and rising NPLs, which issuers are legally obliged to remove from the cover pool. The price stabilisation and sustained OC levels will also increase the range of loans on the issuer's balance sheet that are eligible for inclusion in the cover pool, which fall within the threshold.

Current OC levels in Portuguese covered bonds significantly exceed the legal requirement. Portuguese issuers have demonstrated their commitment to maintaining OC levels in their cover pools. Issuers maintain OC levels well above the legal requirement of 5.3%, at 36.5% on average, some of which is in a committed form. The stabilisation of Portuguese house prices will provide more eligible loans, helping Portuguese issuers to maintain solid OC levels.