OREANDA-NEWS. The potential for mortgage interest-rate floors to become ineffective is a remote risk for Spanish RMBS and mortgage covered bonds, Fitch Ratings says.

Our initial assessment of the recent Madrid court ruling is supported by discussions with trustees and a legal adviser. The full implications will depend on future legal decisions and their applicability to individual mortgage loans, but Fitch does not expect to take rating actions as a result.

A Madrid court ruled this month that interest-rate floor clauses in retail mortgages lacked transparency and were abusive. The ruling did not state that the clauses were illegal, so the implications for affected mortgages may depend on a case-by-case assessment.

Where interest-rate floor clauses are nullified, it is possible that this will apply retrospectively to May 2013. Banks would have to compensate borrowers for excess interest paid from this date. Some banks may appeal the ruling, and the industry is also awaiting a decision from the European Court of Justice on the matter.

We estimate that around 10% of existing securitised Spanish mortgage loans have floor clauses. This varies from lender to lender (from 0% to approximately 80%), but the low levels of excess spread in typical Spanish RMBS deals (close to 1% per annum) suggests that the proportion of securitised mortgages with floor clauses is low.

The biggest potential impact on RMBS transactions could arise if final court decisions confirm that interest-rate floor clauses were abusive because of insufficient transparency at origination, and borrowers have to be compensated as if the clauses had not been present since May 2013. In this case, we expect the originating banks would commit to either buy back affected loans or pay the required compensation to borrowers from their own funds.

However, if banks attempted to pass this risk onto issuing SPVs, it could generate administrative and/or legal costs for the SPVs. This could affect transaction cash flows if new senior costs arise, and potentially affect ratings, as SPVs do not reserve for this contingency.

We think this risk is remote, because SPVs purchase loans from originators with representations and warranties stating that all assets comply with local laws, and because SPVs were not responsible for the origination of such loans.

Some securitisations exposed to mortgages with rate floors would see further income margin reductions if the floors become ineffective. This would go even beyond the spread compression of past years. The magnitude would depend on the number of mortgages with interest-rate floors in the underlying portfolio. Transactions with weak performance trends and no total return swap would be most affected, in particular junior and mezzanine bonds. We will monitor excess spread dynamics but we do not anticipate a ratings impact.

Similarly we do not foresee any material risk to Spanish mortgage covered bonds ratings, mainly because our post-issuer default cash flow models already reflect low mortgage spreads, and Spanish mortgage covered bonds benefit from ample overcollateralisation.

Commentary on the impact of interest-rate floors on Spanish banks is available at www.fitchratings.com (See Fitch: "Interest Rate Floor Ruling to Squeeze Spain Bank Margins").