The Spanish Code of Good Practices (CGP) aims to protect vulnerable mortgage borrowers whose primary residence purchase cost was below €300,000. Royal Decree Law 6/2012 initially regulated the GCP, followed by the additional Royal Decree law 1/2013, which also protected vulnerable borrowers from eviction through May 2020. This measure was extended for another four years in the Royal Decree Law 6/2020 until May 2024. A second code followed in 2022 (Royal Decree law 19/2022) to protect borrowers from the increasing interest rate environment. While most of the Spanish financial institutions have adhered to the CGP, it is not mandatory. Royal Decree Law 1/2024 has extended by four more years the prohibition on evicting vulnerable borrowers from their first residence until May 2028.

The Spanish Government has extended this measure in response to the financial stress faced by families since the second quarter of 2022, as higher interest rates and inflation increased the cost of living. Although inflation is less severe in 2024, there is uncertainty around interest rates decreases and when they will be reflected in mortgage payments. The effects of higher interest rates have been detrimental to vulnerable borrowers who are exposed to variable interest rates in their debt repayment, which has not been mitigated by higher savings rates.

We have observed interest from certain market participants on transactions backed by loans subject to the CGP, which increased in the second half of 2023 and in 2024. Although we have not yet rated transactions with a large share of loans benefitting from the scheme, we have rated various transactions containing restructured loans in Spain. Both types of loans--restructured and CGP--tend to be of lower credit quality given their weaker past performance, but the latter introduce higher risk in our analysis, in our view.

In this Credit FAQ, S&P Global Ratings aims to describe and provide our opinion on the main risks that we observe in portfolios with a significant exposure to loans benefitting from either of the CGPs in Spain.

What are the main characteristics of the CGP introduced in 2012?

This code implements a series of measures to assist vulnerable borrowers, i.e., those considered at risk of social exclusion under the CGP. The criteria consider different aspects of family income and social circumstances. Qualifying borrowers can benefit from several measures until loan maturity.

The terms will vary depending on the deterioration of the borrower's financial condition. Firstly, restructuring measures will be offered to the borrower. However, if the borrower has no assets other than the mortgaged property and if the loan has no additional guarantees, the CGP scheme also offers partial write-off and deed in lieu (see chart 1). The borrower must request these options, and the terms are agreed with their financial institution.

Chart 1

Who is eligible under the CGP?

Borrowers who adhere to the CGP need to meet certain eligibility criteria. The scheme aims to protect borrowers at risk of social exclusion whose loan purpose was the acquisition of their primary residence for an acquisition value below €300,000. Vulnerability is measured by:

• The net family income is below a minimum threshold;
• The share of net family income used to pay down the mortgage instalment is at least 50%; and
• Over the previous four years, either the borrower's financial situation has worsened significantly or the borrower's characteristics affecting family vulnerability have changed, including large family, underage children, or elderly borrowers, among others.

From what we have observed in the Spanish market, the conditions stated above are restrictive and, consequently, only a limited number of borrowers qualify.

Is there any impact on the repossession process if a borrower adheres to the CGP?

Continuing with the measure started in 2013 (Royal Decree Law 1/2013), the Royal Decree Law 1/2024 extended the prohibition of vulnerable borrowers' eviction until May 2028. For CGP loans, the property cannot be repossessed even if the borrower does not meet the agreement made with their lender and eventually defaults. The non-eviction scheme may lead to increased defaults considering the limited consequences on the borrowers. Therefore, unlike reperforming loans--which might have monthly interest and principal collections after being restructured and which also benefit from recovery proceeds in the event of default--and nonperforming loans--which typically rely solely on recoveries--cashflows from CGP loans whether from monthly collections or recoveries may be negligible. In addition to the stresses applied in our credit analysis, we would also give limited credit to recoveries and extend the time to recovery in our cash flow analysis of transactions with a material share of CGP loans.

We expect that the eviction prohibition is likely to be extended after 2028. Our view stems from our consideration of legislative measures over time to extend and widen the protection of vulnerable borrowers in other ways.

What changed with the introduction of the new CGP in 2022?

The new CGP contains measures for borrowers at risk of vulnerability due to the increasing interest rates environment. Unlike the first CGP, which doesn't have a deadline, borrowers can request adherence to this CGP until Dec. 31, 2024. The main measure offered under this code is loan novation, by:

• An up to seven year term extension, but no longer than 40 years from the origination date. The resulting instalment cannot be lower than the June 2022 payment due. The borrower can also ask to keep the June 2022 instalment amount for 12 months.
• Switching from a floating-rate to a fixed-rate loan, free of fees or expenses in 2023.

The borrower conditions are looser compared with the first CGP, allowing more borrowers to qualify.

Do loans subject to the CGP introduce different risks in transactions compared with restructurings outside the GCP's provisions?

To assess the risk of restructured loans that fall outside of the CGP's scope, we apply an adjustment based on the latest restructuring date under our residential loans criteria. Under these criteria, reperforming loans are defined as those that have been restructured or were above 90 days arrears within the previous five years. Seasoning credit is reduced, as it will start from the latest restructuring date. This is to consider the lower credit quality of recently restructured borrowers.

However, we believe that loans subject to the CGP introduce further risks in a transaction. In addition to the lower credit quality of qualifying borrowers together with the long principal grace periods, time to repossess the property could also extend given that the property may be rented to the borrower and repossession may not be executed if the borrower is vulnerable as per the applicable laws. Therefore, in our analysis, the inclusion of CGP-qualifying borrowers would increase our weighted-average foreclosure frequency (WAFF) and our weighted-average loss severity (WALS) assumptions for the entire transaction.

What are our analytical considerations for portfolios with loans subject to the CGP?

We have already rated transactions with a non-material share of loans subject to this code, typically representing below 1% of the portfolio.

For portfolios with a material exposure to the CGP, we would consider the materiality of the loans subject to this code in the portfolio on a case-by-case basis. We look at several factors to assess materiality, including the originator's historical data received on loans previously subject to the code or the exposure to these loans in the portfolio, among others. Credit performance and our credit assumptions are likely to differ between portfolios and will be reflected in our transaction-specific base-case assumptions for any transaction that we may rate in the future. We note the importance of the post-restructuring performance in terms of arrears, pay rates, and recoveries of loans under the CGP provided by each servicer. In particular, the evolution once the interest-only periods have elapsed.

In particular for our WAFF analysis, we expect to see historical information on borrowers subject to this code in the past, to assess whether they have been able to resume their payments and to understand whether restructuring plans were successful. As for our WALS analysis, we believe that the recovery timing and loss severity for loans subject to the CGP will also be affected. Therefore, we will also ask for historical data related to property repossessions to assess our WALS. Under our analysis, we may run different sensitivities with increased defaults, increased loss severity, and extended recovery timing to test the robustness of the collateral under our different rating stresses.

Additionally, some transactions may include provisions to repurchase defaulted loans below par. Such repurchase rights reference the lower of (i) the outstanding balance, and (ii) a certain percentage of the indexed valuation at closing. In those instances, we consider how the projected losses compare to our rating stresses. We also believe that this provision can anticipate recoveries from defaulted assets.

Finally, as measures for loans subject to the new CGP introduced in 2022 are limited and temporary, we believe that they introduce fewer risks in the portfolio compared to loans subject to the 2012 code. In our analysis, we would stress lower collections given the decreased instalments due as well as the extended loan term.

What if borrowers in existing transactions start benefitting from a CGP?

We have observed few borrowers within our rated portfolios turn to the CGP, and we do not expect a significant increase in the short term. Measures such as reductions in loan spreads, grace periods, or longer terms could negatively affect the RMBS transactions that we rate. However, each transaction's structural and collateral features, such as liquidity funds, loan seasoning, and available credit enhancement, could mitigate the potential adverse effects of these measures.

We have performed an analysis on this subject in our previous publication, "Southern European RMBS Grapples With Rising Rates," published on Jan. 25, 2023.

Related Criteria And Research

• How Much Shock Can European RMBS Take?, June 8, 2023
• Southern European RMBS Grapples With Rising Rates, Jan. 25, 2023
• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 25, 2019