OREANDA-NEWS. The proposed law allowing retail mortgage borrowers to return real estate collateral to banks in exchange for writing off their loans could disrupt the Romanian banking sector's improving performance, says Fitch Ratings.

The proposed law, which is subject to Parliamentary review in coming weeks, would apply to new and outstanding retail mortgage-backed loans under EUR150,000. Over 99% of Romanian mortgage borrowers fall under this threshold.

We believe the law would be negative for bank performance on several fronts if passed in its current form. Retail mortgage lending could come under pressure as banks tighten their lending criteria and require higher down payments to protect themselves against potential weakened credit discipline.

In addition, the Prima Casa first-time buyer programme, the main driver of retail lending since the crisis, would likely be terminated. The impact could potentially be substantial as about 20% of total retail loans have been made under the programme since it was launched in 2009. Retail mortgages under the Prima Casa programme require a low 5% down payment and the state guarantees 50% of the loan. But the draft law appears to raise doubts about enforceability of the government guarantee and would likely signify the end of this popular programme.

The draft law may create higher incentives for borrowers to use the debt/asset swap default. But, overall, we do not expect a high take-up rate of the debt/asset swap option among retail customers who are owner-occupiers and current on repayments and neither do we expect a significant deterioration in asset quality in the event that the debt/asset swap is introduced. Sector non-performing exposures, as defined by the European Banking Authority, reached 13.6% at end-2015.

But there is some tail risk. If real estate prices were to decline, borrowers with loans extended under Prima Casa, where LTV ratios are typically high, might become more tempted to use the swap option. Depressed real estate prices - which might occur if banks were to restrict the flow of new credit available for mortgage loans - would also affect the value of other collateral held by banks, potentially leading to additional loan impairment charges and pressure on earnings.

Capital ratios could also come under pressure given a likely increase in risk-weighted assets, as banks would no longer benefit from capital relief on Prima Casa loans. Sector capitalisation would however still remain comfortable, given a total capital adequacy ratio of 17.5% at end-2015.

Romanian banks, including the subsidiaries of Erste Bank, Societe Generale, Raiffeisen and UniCredit, voiced concern about the proposals. Nervousness already triggered a tightening of lending standards, with several large banks announcing increases in down payment requirements on mortgage loans to 35% from a current 15% average for standard retail local currency mortgage loans.

Our outlook for the sector is stable but this could come under pressure in the event of asset quality deterioration, resulting in increased stress on capital. Additional information on the outlook for the sector is contained in a report.