For the past year, the mortgage market across Europe has been hugely distorted, with foreclosures banned, or delayed by payment relief schemes. Emergency measures from governments, banks, and servicers have supported borrowers who lost their livelihoods as economies were shut down to protect lives. Now, those schemes are being withdrawn. The next few months will give S&P Global Ratings a clearer picture of how the pandemic has affected borrowers' capacity to repay their mortgage loans.

As the pandemic spread across Europe, the first emergency response from banks and servicers was to offer borrowers payment relief under their mortgage loans. In some jurisdictions, governments launched mandatory payment moratoriums for borrowers severely affected by the crisis. The European Banking Authority (EBA) in the EU and the Financial Conduct Authority (FCA) in U.K. implemented guidelines in April 2020 that allowed payment moratoriums. Normally, the exposures subject to moratoriums would be classified as forborne or as defaulted under distressed restructuring. The guidelines enabled banks to offer borrowers payment suspensions of three to 12 months on the interest or the full payment due on their mortgages. The guidelines were reactivated in December 2020 (expiring on March 31, 2021) for the benefit of loans suspended by not more than nine months in EU and six months in U.K. in total, including previous suspensions.

Even before the launch of those guidelines, we assessed the potential impact of a significant decrease in collections due to payment holidays. Our analysis suggested that transactions had enough liquidity to withstand several coupon payments, even if collections were to drop by up to 75% (see "European ABS And RMBS: Assessing The Credit Effects Of COVID-19," published on March 30, 2020).

On May 1, 2020, based on our macroeconomic updates and our projections of how the pandemic might affect certain European economies and their residential mortgage markets, we updated our outlook on some mortgage markets (see "Residential Mortgage Market Outlooks Updated For 13 European Jurisdictions Following Revised Economic Forecasts", published on May 1, 2020). We expected increased credit losses in the residential sector and greater mortgage arrears because of higher unemployment forecasts and constraints on consumer demand. The revised assumptions took into consideration the level of government support in each jurisdiction, including fiscal and monetary support to both businesses and borrowers, which we anticipated would offset some income curtailment.

We increased our 'B' foreclosure frequency assumptions for the archetypal pool, and all the interpolated base foreclosures assumptions up to the 'AA+' rating scenario. This triggered only limited RMBS rating actions. Of 17 tranches placed on CreditWatch negative, we downgraded 13 tranches and affirmed four (see "European RMBS Outlook 2021," published Jan. 25, 2021). We already classified the mortgage markets in Italy and Greece as not benign before the pandemic. Accordingly, we did not change our 'B' foreclosure frequency assumptions for these countries. In our view, the then-published foreclosure frequency assumptions and projected loss levels for Italy and Greece were appropriate following our economic updates. We did not change our foreclosure frequencies at the 'AAA' level in May 2020 because our macroeconomic forecasts pointed toward a strong rebound in GDP for 2021 and 2022, and the forecasted unemployment levels did not suggested a decrease beyond those expected during a normal economic cycle (see chart 1).

Chart 1

We do not expect any further revisions in our 'B' foreclosure frequency assumptions in the short term, given that our forecasts for unemployment rates have generally decreased (see "Economic Outlook Europe Q3 2021: The Grand Reopening," published on June 24, 2021), there has been no significant spike in mortgage arrears or credit losses, and house prices continue to hold up.

So Far, So Good

The performance of our rated transactions has not yet shown material deterioration, despite the stresses of the past year. The various initiatives implemented by governments--in particular, furlough schemes and payment moratoriums--supported this stable performance.

Payment holidays have been coming to an end since September 2020; this has not had a material impact on 90+ day arrears, which have remained stable in most jurisdictions (see chart 2). However, we have seen a slight uptick in arrears in the U.K., where the uptake of payment holidays was high and applications closed early, in March 2021. A similar trend is evident in Ireland, where the deadline for applications was even earlier, in September 2020.

Chart 2

Some Borrowers Face A Payment Shock

Our data suggest that 90+ arrears increased by 1.5% for U.K. nonconforming RMBS and by 1.6% for Irish RMBS. These are modest increases, but the arrears have proved difficult to resolve to date. In our view, because the moratorium on repossessing residential property has so far prevented lenders from starting judicial activities against delinquent borrowers, there are fewer incentives for borrowers to enter into friendly resolutions. This reduces the chances of an early resolution of the delinquency status. When litigation activity resumes, courts are likely to face a backlog of cases. We expect it will take months to see a reduction in late arrears.

Some borrowers are rolling into arrears as their payment holiday scheme ends. We expect roll rates to be transaction-specific. It is therefore difficult to forecast roll rates at present, because it will depend on borrowers' evolving circumstances after their payment holidays end and how lenders accommodate these circumstances.

Our early data also suggests that some borrowers, in some deals, may have applied for the deferral scheme so they could clear their historical arrears. We have yet to see if borrowers who took this tactical approach will remain current on their monthly payments if they face further stresses.

Most of Europe's pandemic-related relief schemes have ended or are being wound up. The next few months will give us a clearer picture of the impact of the pandemic on borrowers' capacity to repay their mortgage loans. Table 1 summarizes the status of the various schemes across the main European RMBS markets.

Table 1

Which Jurisdictions Could Be Hit Hardest?

As we reviewed our ratings on the various transactions, we incorporated the likely impact of the end of the support measures. We tested the cash flows of rated transactions assuming different sensitivities, including the impact of an increase in our stressed default rates by 10% due to an increase in arrears. We consider this assumption is appropriate, based on our forecasts for unemployment and GDP levels over the next four years.

Across the main European jurisdictions, payment holiday uptake was highest in Ireland, the U.K., Portugal, and Italy. Of these, the maximum potential rating achievable on RMBS transactions in Italy and Portugal is capped by the rating on the sovereign under our criteria (see chart 3).

Chart 3

We see transactions which experienced low payment holidays uptake as less exposed to the risk of a significant increase in severe arrears.

Our rated transactions in Italy and Portugal comprise very seasoned deals that have high levels of credit enhancement. Many of our ratings on these transactions are constrained at 'AA' by the application of our rating above the sovereign criteria. The classes with ratings below the sovereign cap are, in some cases, constrained by the ratings on the counterparties; if not, they have robust levels of credit enhancement. As a result, we see no rating impact when we apply our sensitivity analysis.

At the start of the pandemic, many U.K. prime transactions were affected by a high level of payment holidays. However, these expired in the second half of 2020 without causing a deterioration in arrears. As a result, our credit assumptions are stable or may even have improved. Thanks to the reduction in leverage, when we test those transactions by applying our 10% increased stressed foreclosure frequency, the ratings remain stable.

U.K. nonconforming and Irish reperforming deals are most at risk of a further increase in late-stage arrears because their borrowers have a weaker payment profile. Nevertheless, our sensitivity analysis indicated that most of our ratings in these transactions would remain stable. In a few cases, the most junior classes showed a rating impact, which is in line with the maximum deterioration we would expect under moderate stress conditions under our credit stability analysis.

Therefore, we do not expect to see a material deterioration in the performance of our rated RMBS transactions in Europe as relief measures come to an end. Even in countries that experienced very high levels of payment holidays, the transactions are likely to remain stable. Only those transactions exposed to more-vulnerable borrowers might show some increase in 90+ day arrears. This would lead to limited rating actions, mainly concentrated in the most junior classes, which are currently rated well below the investment-grade level.

The Need For Payment Holidays Is Waning

We have seen a significant decrease in the use of payment holidays since August/September 2020 across Europe, except in Portugal and, to a degree, Italy. RMBS transactions that are more exposed to borrowers employed in the tourism sector continue to have elevated levels of payment suspensions.

Table 2 gives a snapshot of the main schemes that were in place in June 2020 (see "How European ABS And RMBS Servicers Are Managing COVID-19 Disruption And Payment Holidays", published on June 4, 2020).

Table 2

Chart 4 shows the peaks in uptake of payment holiday in the universe of our rated transactions in Europe, versus the current levels.

Chart 4

Even without the EBA and FCA guidelines, our recent conversations with servicers suggests that banks and servicers will continue to support clients in the tourism/hospitality sectors, who are still facing financial difficulties. Overall, we expect a further reduction in the use of payment holidays over the next few months. Such schemes are no longer available in most countries.

Protections For Borrowers Have Limited Lenders' Options

As a result of the payment, foreclosure, and eviction moratoriums implemented across various jurisdictions, lenders were unable to start legal proceedings against delinquent borrowers. Especially in the U.K., this led to an increase in 90+ day arrears for certain nonconforming RMBS transactions. When the foreclosure moratorium is lifted, we expect foreclosure to take longer because there will likely be a backlog of cases following the suspension.

That said, one year into the pandemic crisis, there is no evidence of major liquidity issues, even though the payment and foreclosure moratoriums constrained the collections available to transactions and could have limited the liquidity available to pay timely interest on the notes.

Since the start of the crisis, we have been closely monitoring all transactions for signs of potential liquidity shortfalls. We divided our rated transactions into three groups--high, medium, and low risk--depending on the features of the loans and of the deal structure. For deals we classify as high or medium risk, we have been tracking indicators such as level of collections, arrears, and payment holidays, for early signs of a deterioration in performance that could affect our ratings.

Since early last year, we have also tested the potential impact of lower collections in our analysis by assuming that 25% of collections were delayed for six months and received after 36 and 48 months. We sized the stress at a level we considered appropriate--the situation was extremely uncertain and there was little visibility on how the payment holidays were going to evolve. As investor reports gave us further evidence regarding the uptake of the payment suspensions, we were able to adjust our assumptions and make them deal-specific.

We incorporated the potential delay in repossession caused by the foreclosure moratoriums in our analysis. Our scenarios included extended recovery periods of six to 12 months longer than usual--the longer extension was applied in jurisdictions such as the U.K., where our foreclosure timing is typically shorter.

We found that these additional liquidity stresses had little effect on our ratings because most transactions benefitted from internal or external forms of liquidity. To date, we have seen no major liquidity issues in the transactions that we rate and we no longer classify any of the deals as high risk.

Interest rates are extremely low in the U.K. and negative in Europe. This reduced the cost of the notes (see chart 5). Transactions also had access to cash reserves and principal borrowing mechanisms that provided emergency liquidity funds. That said, only a few deals in Spain and the U.K. drew on such reserves, and then only to a limited extent. The deals affected are very seasoned deals with small pools that have limited excess spread available to cure defaults. Even in benign circumstances, they experienced minor draws.

Chart 5

Even in those jurisdictions that saw the highest uptake of payment holidays, the ratio between interest collections and interest paid on the rated notes has not deteriorated dramatically, see chart 6 for a sample of U.K. nonconforming deals.

Chart 6

Flexible Servicing Could Help Sustain Performance

We expect that borrowers who cannot pay, and who have already used their full entitlement of payment deferral, will be treated in accordance with the policies of their servicer and lender. Generally, treatment of borrowers is likely to be tailored to their individual circumstances. We anticipate that servicers will make use of multiple servicing strategies such as rate reductions; term extension; and, in extreme cases, principal forgiveness. All of these forbearance strategies were used before the pandemic, to a limited extent, and may allow a more gradual build-up of arrears, rather than a sudden, potentially damaging, spike.

Servicers are typically far better equipped, in operational terms, to deal with the servicing intensity required to manage borrowers facing economic stress than they were in the wake of the 2008 global financial crisis. The combination of deferral and furlough schemes has given servicers over 18 months to analyze where the risks lie within their portfolios. In our view, servicers and lenders that are able to devise and roll out servicing strategies to afford borrowers with the greatest needs the most consideration will see stronger performance in future.

Editor: Heather Bayly.

Related Research

• Economic Outlook Europe Q3 2021: The Grand Reopening, June 24, 2021
• Europe's Housing Market Will Chill In 2021 As Pent-Up Pandemic Demand Eases, Feb. 22, 2021
• European RMBS Outlook 2021, Jan. 25, 2021
• How European ABS And RMBS Servicers Are Managing COVID-19 Disruption And Payment Holidays, June 4, 2020
• Residential Mortgage Market Outlooks Updated For 13 European Jurisdictions Following Revised Economic Forecasts, May 1, 2020
• Europe Braces For A Deeper Recession In 2020, April 20, 2020
• European ABS And RMBS: Assessing The Credit Effects Of COVID-19, March 30, 2020