According to the European Securitisation Forum Autumn 2007 Report’s ranking of European securitisation issuances by country of collateral, the Spanish securitisation market has consolidated its second place position. The strong position in the RMBS sector has been one of the reasons contributing to this extraordinary performance.
Yet, recent developments in the international markets have caused a deceleration in the growth of the Spanish refinancing mortgage market. The illiquidity of capital markets, as well as the special impact of the US subprime crisis on the confidence of the global capital markets toward Spanish mortgage-related products, however unfounded it may be, has affected the issuance of RMBS as well as structured and non-structured covered bonds by Spanish credit entities and securitisation vehicles.
Last 9 December 2007, Law 41/2007 of December 7 2007, entered into force. Law 41/2007 amends Law 2/1981 of 25 March, regulating the mortgage market and setting the foundations for a mortgage-backed financing market by means of a legal framework for the issuance of mortgage-related securities which would allow Spanish originators to finance lending activities.
Although the approval procedure by the competent Spanish legislative bodies began almost nine months ago under an entirely different market scenario, the enactment of Law 41/2007 is particularly relevant given current market conditions. Law 41/2007 will help preserve the importance of a strong and liquid local mortgage market as a fundamental driver of GNP by introducing legal developments aimed at modernising the mortgage-related regulatory framework, including, amongst others, a wider array of mortgage-related products and greater flexibility in the means of refinancing already available for Spanish financial institutions.
Mortgage-related securities according to Law 2/1981
Under Law 2/1981, certain Spanish financial entities are legally authorised to issue mortgage-related securities. In order to further strengthen the quality of the securities, Law 2/1981 introduced the concept of a “preferred” or “premium” class of mortgage loans that are subject to stringent requirements, including a maximum 70 percent loan-to-value (LTV) ratio (80 percent for residential assets), the need for mortgaged assets to be appraised by an independent appraisal firm and covered by damages insurance, the need to have a first ranking mortgage or a limitation of the authorised uses of funds for the debtor.
The categories of mortgage-related securities set out in the Spanish mortgage market regulations include covered bonds (cédulas hipotecarias or “CH”), mortgage bonds (bonos hipotecarios or “BH”), mortgage participations (participaciones hipotecarias or “PH”) and mortgage transfer certificates (certificados de transmisión de hipoteca or “CTH”).
CHs are corporate bonds (i.e., the bondholder has recourse against all assets of the issuer). The principal and interest of the bonds are specially secured by a non-registered “mortgage” or special lien on all the mortgage loans registered in the name of the issuer from time to time with the Spanish land registries (except for mortgage loans linked to the issue of other mortgage-related securities). Therefore, holders of a CH enjoy a privileged right against the issuer that is enforceable even in the event of the issuer’s insolvency.
BHs are bonds as well, but differ in that the principal and interest of these bonds are specially secured with a separate set of mortgage loans that are registered in the name of the issuer with the Spanish land registries. While a holder of a CH enjoys something similar to a floating charge on the pool of mortgage loans that the issuer may hold from time to time, the holder of a BH enjoys the benefit of a registered “mortgage” or special lien only on each of the loans specifically identified in the issuance deed. Another difference between these two types is that, before the enactment of Law 41/2007, the issuance of BHs needed to be registered with the relevant land registries and the setting up of a formal syndicate of bondholders was required.
A PH is a mortgage-related security used to transfer risk and benefits to a mortgage loan. Unlike CHs and BHs, which are debts of the issuer, a holder of a PH participates in the whole (or a part only) of the amounts owed under a given mortgage loan granted by the issuer. The issuer continues to be the holder of record of the mortgage loan and will service the debt, but all rights to the amounts owed by the debtor under the loan are transferred to the holder of the PH. Certain enforcement rights vis-à-vis the debtor will also vest in the context of mortgage foreclosure proceedings.
CTHs are PHs linked to “non-preferred” mortgage loans. Direct transfer of mortgage loans requires registration with the appropriate land registry to be enforceable vis-à-vis third parties and is subject to a stamp duty ranging from 0.5 to 1 percent over the amount secured with the mortgage; however, the issue, transfer, cancellation and reimbursement of mortgage-related securities are exempt from stamp duty and no registration formalities are required (except for the BHs). The advantages in terms of corresponding costs have made mortgage-related securities (especially, CHs, PHs and CTHs) very popular products in the European market, whether issued directly or when structured in the context of securitisation transactions.
PHs and CTHs lie at the core of the extremely successful mortgage-backed securitisation funds (FTH) and asset-backed securitisation funds (FTA) which acquire PHs and CTHs on the back of the issuance of RMBS notes. In turn, CHs have often been used in the issuance of “structured” covered bonds, a class of ABS notes issued by local FTAs that securitise a portfolio of CHs issued by different originators.
The most significant changes introduced by Law 41/2007 to Law 2/1981 can be divided into three groups: (i) those aimed at developing the BH market, (ii) those providing more flexibility to the issuers of mortgage-related securities, and (iii) those improving the legal position of the mortgage-related securities holders.
The Spanish BH market
Potential issuers of BHs have traditionally disregarded this type of refinancing mechanism in favour of the other types of mortgage-related securities. This is especially true in the context of high volume transactions. The rationale of the decision is usually based on the higher administrative costs derived from Law 2/1981 associated with an issue of BHs in comparison with those incurred with alternative securities, as well as on other structural restrictions.
Law 41/2007 attempts to put BHs on the same level as the other mortgage securities by:
(i) eliminating the requirement of recording the “mortgage” or special liens to be created on each of the identified mortgage loans which will secure the BHs with the land registries;
(ii) requiring that only “preferred” mortgage loans be used as underlying assets for purposes of the perfection of the “mortgage” or special lien for the benefit of bondholders and also requiring that the net present value of the BHs may not exceed 98 percent of the net present value of the underlying assets (but not that the average maturity of BHs exceeds that of the underlying assets, as previously required); and
(iii) making optional the incorporation of a syndicate of bondholders, which was mandatory before.
Increased flexibility for issuers
Other provisions of Law 41/2007 attempt to make the mortgage-related security a more sophisticated instrument, to modernise the issuance structures and therefore to improve the position of financial entities as mortgage securities issuers and originators.
These provisions include: (i) Larger mortgage portfolio: Loans secured by real estate assets located in other EU Member States (provided that the relevant security has a similar legal nature to that of a mortgage under Spanish law) may be eligible loans for purposes of the issuance of mortgage-related securities; (ii) Liquid assets: Issuances of BHs and CHs could be backed with certain types of low risk and high liquidity fixed income securities and other assets referred to as “replacement assets” (activos de sustitución) up to certain limits, thus helping the issuers to mitigate the liquidity risk often associated with these securities;
(iii) Larger number of eligible investors: The number of potential investors in CTHs is formally extended to include “qualified investors”, Spanish legal term under which credit entities and many other sophisticated investors are included, which could multiply the alternatives available to financial entities for structuring transactions involving this type of mortgage-related security, in Spain and abroad; (iv) Additional uses of funds: Permissible uses of funds within the restricted class of “preferred” loans are further extended.
Improved conditions for investors
The reforms introduced by Law 41/2007 will make mortgage-related securities a more attractive instrument from the perspective of potential investors. First, they offer improved financial support. In addition to the respective mortgage guarantee referred to above, principal and interest of BHs and CHs will be secured (whether in an issuer’s ordinary or insolvency scenario), with (i) any replacement assets securing the BHs or CHs, and (ii) any cash flows generated by derivative instruments entered into by the issuer in the context of the issue.
Second, insolvency scenarios. In addition to the privileged security status pursuant to Law 2/1981, a new paragraph that Law 41/2007 has added will require the insolvency trustee, in order to repay the amounts due to the holders of BHs and CHs, to liquidate the replacement assets or even to enter into financing transactions with third parties to generate additional cash.
Third, the maximum LTV ratio for mortgage loans (other than residential mortgage loans) will be reduced from its current ratio of 70 to 60 percent (the maximum LTV for residential assets will remain at 80 percent) and, as a result, the quality of the eligible underlying mortgage loans portfolio should increase.
Finally, according to Law 41/2007 the outstanding principal of CHs shall not exceed 80 percent (instead of 90 percent as under Law 2/1981) of the outstanding principal amount under the “preferred” loans portfolio (net of the loans which have been subject to an issuance of BHs) making the threshold more restrictive to the issuer and more protective of each CH holder.