Policies introduced in an attempt to control the COVID-19 pandemic have had a major effect not only on macroeconomic forecasts but also on work routines and processes. Certain funding instruments, like structured finance transactions, which rely on key transaction parties' adequately performing their roles, will possibly face increased stresses in the coming months. In order to assess how loan servicers across Europe are dealing with the unprecedented situation, S&P Global Ratings have had discussions with servicers for European residential mortgage-backed securities (RMBS) and asset-backed securities (ABS) transactions to understand their business continuity plans and the nature and scale of disruption (if any). We have also looked at the rate of borrowers' payment holiday utilization and whether these will be reported as arrears.

Frequently Asked Questions

How have servicers responded from an operational perspective to the change in the working environment?

Most of the servicers we contacted have initiated their business continuity plans to help both their clients and their employees. While most plans envisaged the use of a back-up site rather than wholesale working from home, no major issues have been highlighted and the servicers have been able to continue handling borrower requests remotely. In some cases, servicers have incentivized clients to use remote contact channels like online banking, while some have created newsletters to keep clients up to date on their operations. IT infrastructures have been reinforced where necessary. Additionally, some servicers have created specific internal teams and/or steering committees to monitor and respond to the evolving situation.

Has COVID-19 led to significant staff disruption?

The fallout of COVID-19 on staffing levels appears to be limited. Some servicers highlighted that while there has been absenteeism due to illness, it was not to a degree to materially affect the company's operational capability.

How prevalent is the take up of payment holidays for residential assets?

Our estimate of payment holiday utilization considers a variety of sources, including discussions with servicers, originators, investor reports, and other publically available sources.

Chart 1

What is driving the difference in payment holiday utilization?

Incentives and disincentives of use, together with ease of accessing schemes vary across the region. The creation of a legal scheme, operational aspects, and borrowers' credit quality are driving different levels of utilization both between servicers in the same country and when comparing country to country, in our view.

Table 2

Legal schemes.   Payment holiday schemes have been introduced by legislation in various European countries. However, this is not the case in the Netherlands or France, where payment holiday approvals are at the lenders' discretion. The particularly low initial uptake in the Netherlands may also be explained by uncertainty as to whether borrowers would lose beneficial tax treatment on loan interest if they took out a payment holiday.

French mortgage loans often include in the contracts a provision for payment holidays available at any point in time, although the approval is always at the banks' discretion. During the COVID-19 pandemic, servicers have seen a significant increase of these requests, but overall the utilization remains low.

The Italian government introduced a payment holiday scheme for primary residency mortgage borrowers who have had a reduction in working hours or, for self-employed and independent contractors, decreased turnover. The benefit of the Italian Decree is that half of the interest accrued during the payment holiday period is paid by a government fund. However, the application process is long and subject to a detailed review of the supporting documentation. Furthermore, the strict criteria mean that some borrowers may be denied the payment holiday.

Operational factors.  Operational capacity to deal with payment holidays is also driving overall utilization. For example, in some jurisdictions the servicer would typically first speak to a borrower to ascertain their eligibility. Therefore, borrowers who are not considered to need a payment break would be declined. In contrast, servicers in the U.K. have generally allowed borrowers to 'self-certify' their need for a payment holiday without challenge via a telephone call. This expedited process may have led to an overall higher utilization rate, and could explain the wide payment holiday range within the country.

Individual banks in Italy have also been offering their own payment holiday programs, for either principal instalments or both interest and principal. Each lender's eligibility criteria and payment holiday duration may differ somewhat compared with the Decree's, but the application process is much shorter. Consequently, and given the abovementioned hurdles, some borrowers prefer to request payment holidays directly from the bank, even if they do not have the benefit of 50% accrued interests paid. This might explain the wide range of payment suspension in Italy and also the relatively high utilization rate, which is not necessarily a reflection of lower credit quality borrowers.

Borrower credit quality.  Although the underlying borrowers' credit quality is partly driving payment holiday utilization, it seems secondary to operational considerations. For example, UK Finance recently reported that 1 in 6 mortgage borrowers in the U.K. were utilizing a payment holiday. Based on observed performance trends in our rated universe, we consider that nonconforming assets may exhibit generally higher utilization than the overall industry average of 1 in 6.

Furthermore, the underlying eligibility criteria of the various payment holiday schemes is also diverging utilization rates across jurisdictions. In the U.K., a payment holiday will be available irrespective of whether the borrower is current or not, while other countries require the borrower to be current.

However, prime assets in the U.K. are seeing significantly higher utilization than prime broadly comparable assets in other countries, notably Ireland, Spain, France, and the Netherlands. Also, borrowers may consider a payment holiday in a historically low interest rate environment to be a very cheap insurance policy against uncertainty. This may explain to some degree higher utilization rates in countries like the U.K., where protections against redundancy are generally lower than elsewhere in the continent.

For Irish RMBS transactions that we rate, all lenders and servicers are currently offering payment holidays to support all of their borrowers. The amount ranges from about 5% to 12% of the pool balance for prime asset pools. The holidays have terms of up to six months, depending on the lender and asset pool characteristics (see "How Credit Distress Due To COVID-19 Could Affect Irish Reperforming RMBS," published on June 3, 2020).

Overall, the wider ranges within the same countries are mostly due to differences in borrower characteristics. For example, In Spain, some originators focus their mortgage activity on local markets comprising primarily prime borrowers. In addition, similar to Italy and Portugal, we have seen Spanish lenders offering payment holiday to support borrowers that were illegible for the moratoria granted by the government.

What about buy-to-let?

Overall, we estimate buy-to-let payment holiday utilization in line with the averages for the respective countries. For professional landlords with interest-only mortgages, the consequence of using a payment holiday is having to pay interest on unpaid interest and as such may represent a cheap hedge against COVID-19 uncertainty.

Are payment holiday rates beginning to stabilize?

It is too early to conclude if they have peaked, but given recent and further anticipated relaxations in lockdowns there is reason for optimism that if we are not yet at the peak then we are approaching it.

However, each country's operational approach to granting payment holidays and exactly when the schemes were introduced might be delaying payment holiday utilization. For example, we are less likely to be near the peak for lenders who are vetting each application individually, rather than approving all requests.

Additionally, the utilization of payment rates should be seen in the context of the overall level of state support being offered to consumers. Utilization rates in Spain are generally lower than in Portugal and Italy, partly because the eligibility criteria in Spain are more stringent and limiting. However, this relationship among jurisdictions may change. The utilization rate in Spain could rise once the government begins to scale back unemployment and furlough measures, leaving vulnerable borrowers to seek out payment holidays through their loan servicers.

Finally, for certain jurisdictions, there might be a surge in cases as the deadline to apply for payment holidays inches closer.

Are borrowers canceling direct debit payments?

For now, there haven't been widespread instances where servicers are observing cancellation of direct debits that would be seen as materially different from the norm.

Cancellation of a direct debit would ordinarily lead to an arrears balance. If a borrower subsequently applies for a payment holiday, it is not currently clear whether it will apply retroactively and whether arrears balances arising from canceled direct debits would be reclassified as payment holidays. This may lead to volatility of reported arrears, which could, in extreme cases, breach transaction triggers.

Will payment holidays be treated as loans in arrears?

Generally speaking, payment holidays will not be treated as loans in arrears. This is not the case for some of lenders in the Netherlands, where loans granted a payment holiday will be considered as being in arrears. We have observed that some initial investor reports have listed loans that were under payment holidays as being in arrears. These loans might be later reclassified as being payment holidays.

In some jurisdictions, the sellers may buy back some of the loans in private payment holidays (those not granted by the government), which decreases the risk of arrears once the payment holiday expires. However, this will likely occur on a case-by-case basis and will depend on the limits established in the transaction documents.

How will payment holidays be resolved?

Some payment holidays may be extended and, therefore most resolution strategies are still being devised. However, just as operational capacity has driven the utilization rates of payment holidays, we expect the reverse to apply when it comes to resolution. Countries with high utilization rates will likely be less able to offer tailored resolutions to individual borrowers, offering instead a "one size fits all" approach, in our view. That said, resolution could also become legislated in some jurisdictions.

Which data will be available to monitor payment holiday use?

Most of the servicers can provide information on payment moratoria or other products offered, such as movement to interest-only. Some of this data may not be available in the public domain. We understand that most servicers with a reluctance to put sensitive data in the public domain will provide information bilaterally to S&P Global. We expect all servicers to comply with our data requirements when reporting this information (see "Reporting Requirements For COVID-19 Payment Holidays In European Structured Finance," published on May 27, 2020).

What is the situation for ABS?

We have started receiving monthly reports for ABS transactions, in addition to the feedback from servicers. Therefore, we can already provide an initial indication of the use of payment holidays in European ABS transactions. As with RMBS, there are different percentages of payment suspension depending on jurisdiction, asset type, and the underlying type of debtors.

In Germany, auto loan and lease ABS have so far had few payment holidays (1%-2%). The German government's scheme grants payment suspension for three months (strictly up to June 2020) and the underlying debtors are primarily retail, which may explain, together with the secured nature of those receivables, the limited numbers. Equipment ABS in Germany show a slightly higher range of 3%-5%, possibly because these are backed by commercial borrowers, who generally felt the COVID-19 blow more strongly. Finally, unsecured consumer ABS show payment holidays in a range of 5%-10%.

In the U.K., the percentage of payment holidays in auto loan portfolios falls between 1% to 5% for prime borrowers, while for non-prime borrowers the figure more than doubles, in the 10%-20% range. Generally, lower credit quality borrowers have a higher propensity to take payment holidays. On the other hand, equipment lease transactions have a small exposure to payment holidays (2%-3%), possibly because the leases comprise less-affected industries compared with the employment sectors for underlying borrowers in auto loans. For U.K. credit card transactions, payment holidays are quite limited so far, between 2% and 5%, with more non-prime borrowers taking payment holidays than prime borrowers.

Other jurisdictions are displaying similar trends across asset type and borrower type, with a few exceptions. In Italy, there is a high level of payment holidays--ranging from 40% to 50%--for equipment leases, which are backed by small and midsize enterprises (SMEs). Italian SMEs have been strongly hit by the COVID-19 crisis, especially compared with Italian residential mortgage loans. To help mitigate the economic blow, the government decree offers a large-scale payment suspension scheme to Italian SMEs, which partially explains the high utilization rates.

Related Research

• How Credit Distress Due To COVID-19 Could Affect Irish Reperforming RMBS, June 3, 2020
• Reporting Requirements For COVID-19 Payment Holidays In European Structured Finance, May 27, 2020
• European Auto And Consumer ABS: Analysis Adjusted To Reflect COVID-19 Effects, May 11, 2020
• Residential Mortgage Market Outlooks Updated For 13 European Jurisdictions Following Revised Economic Forecasts, May 1, 2020
• European ABS And RMBS: Assessing The Credit Effects Of COVID-19, March 30, 2020