In this Portuguese residential mortgage-backed securities (RMBS) primer, S&P Global Ratings provides a comprehensive guide to the fundamentals of the Portuguese housing, mortgage, and RMBS markets. We also describe the key features and risks of loan origination and summarize the Portuguese securitization legal framework.

Almost 74% of all newly originated residential mortgages in 2024 have an initial fixed rate lasting between one and five years, after which they switch to a floating rate. This should mitigate the impact on households from increasing interest rates.

Improving Performance Following Significant Market And Sovereign Stress

The performance of Portuguese RMBS transactions deteriorated during the global financial crisis. It broadly tracked the unemployment rate, which peaked at 18.1% in the first quarter of 2013. Austerity measures that the Portuguese government implemented in 2018 in the form of spending cuts, tax increases, pension cuts, and welfare benefit reductions, together with a contracting economy, increasing unemployment, tight credit conditions, and lower disposable income, had a negative effect on Portuguese household confidence and debt. Overdue residential mortgages peaked in the third quarter of 2016.

Since 2020, asset performance in the Portuguese RMBS transactions that we rate has been broadly stable. The Portuguese transactions in our RMBS index are highly seasoned, with low loan-to-value (LTV) ratios, and the index performance reflects this. The Portuguese mortgage market's overall performance, as per the Bank of Portugal's reports, shows a similar trend.

As variable-rate mortgages have traditionally dominated the Portuguese residential mortgage market, recent interest rate hikes have resulted in a higher debt burden. Despite this, performance has remained solid, with only a minor deterioration following the recent rate hikes (see chart 1). We attribute this to the following:

• The progressive concentration of the mortgage stock among higher-income households;
• The improvement in new borrowers' risk profiles as a result of the macroprudential recommendations in 2018, which have proven effective in stabilizing credit cycles and containing bank risk; and
• The implementation of government measures to support households, such as the release of nearly €4 billion to offset inflation in 2022.

The measures included an extraordinary payment of €125 to each citizen earning up to €2,700 a month; an extraordinary payment of €50 per descendant; an extraordinary supplement for pensioners equating to half a month's pension; and reductions in VAT on electricity bills.

Chart 1

Portuguese Lending And Underwriting Standards And Their Impact On Performance

We view Portuguese banks' lending and underwriting standards as prudent. In 2018, the Bank of Portugal introduced macroprudential recommendations relating to new credit for house purchases and consumer credit, including limits on LTV, debt service-to-income, and debt maturity ratios. Other recommendations followed in 2021-2022, including measures to strengthen the legal and regulatory framework for managing nonperforming exposures.

In 2023, almost all new loans for house purchases had an LTV ratio of 90% or less, with the average LTV ratio standing at 69% at origination. At the same time, foreign-currency lending remains limited, at less than 1% of total lending at end-2023.

Portuguese mortgage performance was strong during the COVID-19 pandemic. In 2020, the Portuguese government implemented moratorium schemes to help mortgage borrowers. These schemes ended in September 2021 and we did not observe any material deterioration in performance as a result. This was despite the high take-up of moratorium schemes in Portugal compared to other European countries.

Mortgage Regulation Continues To Tighten

Mortgage products in Portugal are generally simple. Most mortgages are amortizing loans, with full consideration of affordability and limited tolerance of borrowers' negative credit history. There is no buy-to-let market. Mortgage providers generally consider properties intended for rent as second homes and underwrite the mortgages on them using the borrower's income. Housing equity is generally not used for debt consolidation or equity release (see table 1 for recent regulatory changes).

That said, 40-year-long mortgages have been prevalent in Portugal. Longer maturities lower the monthly payments and may be symptomatic of low affordability. However, changes in regulation in 2018 recommended that the average maturity of new credit agreements should gradually converge to 30 years by 2022. In 2022, the government introduced regulation to align the maximum maturity of new mortgages with borrowers' ages to promote convergence to 30-year maturities. We consider this credit positive.

Table 1

Strong Housing Market Fundamentals Also Support Portuguese RMBS

Portuguese house prices have proved resilient in the past decade. Contributing to price increases in recent years have been housing supply shortages, reflecting lower construction activity in the pre-pandemic era, and, more recently, higher construction costs and labor and material shortages. The now-defunct golden visa scheme, a residency-by-investment program designed for non-EU citizens, also contributed to price increases.

Nevertheless, the share of residential real estate transactions financed with domestic credit remains much lower than before the global financial crisis. The share stood at 46% in 2023--33% excluding renegotiations and loans transferred from one entity to another--compared with 66% in 2009, according to Bank of Portugal data.

In general, as long as the labor market remains resilient, we do not expect mortgage performance--which accounts for about 48% of Portuguese banks' total lending--to change significantly. A mix of demand and supply factors are behind this resilience. Portugal has one of the highest home ownership rates in Europe (see chart 2). This is because social and institutional rental housing is almost nonexistent in Portugal compared to other European countries.

Chart 2

Foreign Demand Is A Key Driver Of The Portuguese Housing Market

Foreign demand has led to rapid price increases in the past few years, boosted by Portugal's geographical location and economic stability. The government's plan to scrap the golden visa scheme, a residency-by-investment program designed for non-EU citizens, should contribute to moderating prices in the medium term. Non-EU citizens represented 17% of total nonresident citizens investing in real estate in 2022.

The Portuguese residential real estate market sees heavy demand from nonresidents and foreign citizens residing in Portugal. This trend has increased over the past ten years. Since the second half of 2021, transactions by non-EU citizens have exceeded those by EU residents. At the same time, the number of transactions in euro terms has decreased by 16% since the second half of 2022. It is worth noting that information on purchases by nonresidents tends to underestimate the importance of foreign citizens in the residential real estate market, as many subsequently become residents of Portugal (see chart 3).

Chart 3

Market-Specific Considerations

Portuguese residential loan origination was stable from the early 2000s until 2020 (see chart 4). Total outstanding monthly mortgage volumes exceeded €100 million between the end of 2007 and mid-2015 (see chart 5). Thereafter, they decreased until mid-2021. Since the end of 2022, total outstanding monthly mortgage volumes have stagnated at around €100 million.

Since then, origination volumes have steadily decreased, and now represent roughly 70% of the previous 20-year average. Inflation and a tighter monetary policy have contributed to the decrease in origination volumes since 2022.

Chart 4

Chart 5

Lengthy recovery timing and borrower-friendly regulation

Portugal is a full recourse market, meaning that lenders typically have full recourse to all the assets of a defaulting borrower, and typically pursue any mortgage shortfalls vigorously, creating strong incentives for borrowers to pay. However, the repossession process is lengthy and certain borrowers are afforded additional protections.

Portugal's foreclosure proceedings are lengthier than those in most European jurisdictions. That said, over the past few years, the Portuguese government has implemented reforms in the legal and institutional framework for debt enforcement, insolvency, and debt restructuring. However, we anticipate that these measures will need time to yield significant results.

Furthermore, as in other European countries, Portugal has recently introduced various legislative initiatives with a view to protecting vulnerable borrowers. These initiatives started following the financial crisis and have been reinforced over time to address borrowers' challenges. Given the long time to repossession, lenders focus on the early stages of the recovery process, which generally proceeds as follows:

• The lender will try to negotiate a restructuring of the mortgage with the borrower--such as by using a term extension or interest-only periods, for example--to reach an amicable agreement.
• In parallel with, and to leverage these negotiations with the borrower, it is standard practice for the lender to initiate foreclosure proceedings in accordance with the law.
• If, despite all these efforts, the mortgage repayment appears too difficult for an amicable agreement to be reached, the loan is accelerated, triggering the recovery of the full mortgage amount.
• The lender may seek a consensual sale of the property, or as a last resort, the foreclosure of the secured property in its capacity as mortgagee. At the end of the foreclosure process, the secured property is repossessed and is mandatorily subject to sale at auction.

Brokers have come back to the market

A notable change in recent years is that brokers have gradually increased their involvement in the origination process, as banks have closed branches for cost-cutting reasons. We now expect them to introduce more than 70% of new mortgages.

In the run-up to the global financial crisis, Portuguese banks used brokers to widen the sales reach of their mortgage products. This was often poorly controlled from a credit perspective, with brokers assuming some parts of the underwriting process that the banks themselves should have undertaken. Our analysis of broker use focuses on the performance of such loans and the control mechanisms in place to minimize conflicts of interest.

Furthermore, after the abolishment of stamp duty for people under 35 years old in August 2024, the market saw an increase in people in this age group taking up new mortgages.

Comparing Portuguese RMBS With Covered Bonds

Portuguese banks have two realistic secured funding options: RMBS and covered bonds. Table 2 summarizes the key differences between Portuguese RMBS and covered bonds. Covered bonds are an important secured funding tool in Portugal. A specific covered bond law ensures eligibility of the collateral pool--that is, prime borrowers and fully performing loans--but no such law exists for RMBS. RMBS transactions could contain negatively selected collateral that is not eligible for covered bond programs under the covered bond legal framework.

Table 2

RMBS Market Overview

Issuance

There have been only three RMBS transactions in Portugal in recent years: RMBS Green Belem No. 1 (April 2020), Embo Mortgages No. 1 (which we rated in November 2020), and RMBS Belem No. 2 (October 2022). There has not been any Portuguese RMBS investor-placed issuance in the past decade. Securitizations are generally used as collateral for repo transactions with the Eurosystem.

Typical RMBS structures

Portuguese RMBS transactions are typically structured with multiple floating-rate tranches rated from a senior class, often rated 'AAA', to speculative-grade ratings. Most securitizations share features such as split priority of payments for interest and principal, with principal borrowing mechanisms, whereby principal can be used to pay interest and senior expenses. When this happens, a principal deficiency ledger (PDL) is booked. A PDL is also booked when loans are classified as being in default. Typically, an increasing percentage of the loan balance is booked as the loan transitions through the different stages of delinquency. PDLs are cleared in the revenue waterfall after each class of interest.

Often issuers enter hedging agreements to cover interest rate and basis risk, and sometimes other risks, such as the potential costs of servicer replacement. Revolving portfolios are rare. Pro rata amortization--common in the lead-up to the financial crisis--has not been common in Portuguese securitizations.

Portuguese Securitization Law Overview

Portuguese securitizations are governed by a specific securitization law that was enacted in Portugal by decree-law no. 453/99 of Nov. 5, 1999. It has since been amended by various other decree-laws. The Portuguese securitization tax law was enacted by decree-law no. 219/2001 of Aug. 4, 2001, and has also been modified by various other decree-laws.

The Portuguese courts' application of the securitization law and any Portuguese governmental or regulatory authority's interpretation of its application has been limited to a few cases. These cases concern the effectiveness of the assignment of banking credits to borrowers, despite the absence of borrower notification and the format of the assignment agreement.

Bankruptcy remoteness

For the purposes of the securitization law, Portuguese securitization entities are incorporated as bankruptcy-remote as they are special-purpose entities with no legal framework, and therefore cannot be declared insolvent under the insolvency law. The management company constitutes, manages, and legally represents the special-purpose entities.

Commingling risk

Usually, borrowers pay their installments by direct debit to a collection bank account provided by a commercial bank, which for bank-originated transactions, may be the same as the originator. Therefore, these collections could risk being commingled with the servicer's insolvency estate. However, as per the securitization law, there is a statutory segregation of the collections, which are autonomous assets, and they do not form part of the servicer's insolvency estate.

There is a risk that collections may, from an operational point of view, be temporarily commingled with other monies. We consider that if this happened, it would only be a liquidity issue for a limited period of time. The amounts at risk depend on both the amounts accumulated in the servicer's collection account before the servicer's insolvency (accumulation risk), and the amounts that may be paid to that account following the servicer's insolvency and before the borrowers are asked to pay into the issuer account (notification risk).

Setoff risk

Under Portuguese law, the setoff rights crystallize at closing. At closing, we consider the deposits held by borrowers who have loans in the portfolio to be securitized. Deposits with credit institutions based in Portugal are protected by the Deposit Guarantee Fund up to a maximum of €100,000. Amounts exceeding the €100,000 maximum are subject to setoff exposure. We consider them a loss on day one of the transaction under our cash flow analysis.

Clawback risk

For Portuguese RMBS, the sale of the portfolio to the issuer may not be subject to clawback risk. The assignment of credits for securitization purposes under the securitization law cannot be challenged for the benefit of the assignor's bankruptcy estate unless such an assignment is concluded in bad faith. Payments made to the assignor in respect of credits assigned prior to a declaration of bankruptcy do not form part of its bankruptcy estate even when those credits' maturity date follows the date of such declaration.

As of closing, the issuer is not a bankrupt entity. In addition, all collections relating to the assets and held or received by the servicer will not form part of the servicer's bankruptcy estate. Under Portuguese law, the sale of receivables in the context of a securitization transaction where the receivables are sold for the same amount as their outstanding principal, and where the originator retains the notes in full, is not considered to have been carried out in bad faith.

Operational risk

The Portuguese mortgage portfolios that we rate consist of prime home loans that do not require intensive servicing. In our opinion, several entities could step in if the servicer becomes unable or unwilling to perform its duties during the transaction's life. There is a variety of specialized servicers with long track records of acting in the Portuguese mortgage market. Therefore, the potential effect of disruption on the issuer's cash flows is limited.

Regulatory environment

We consider Portugal more borrower-friendly than some other European countries. Even for borrowers who are not considered vulnerable, the Portuguese repossession process is much longer than that in the U.K. or the Netherlands, but it is aligned with that in other Southern European countries. We assume in our criteria that it could take up to 48 months to repossess a property in Portugal. The exact length of time depends on various factors.

Mortgage assets have proved resilient to the pandemic and energy-price shocks. We could still see some asset-quality deterioration due to the delayed effects of inflation and an increase in financing costs. However, we think this should be manageable, as economic growth will continue supporting employment and deleveraging will continue. In particular, we expect the domestic banking sector's problem loans ratio to peak at about 5.0% in 2025, compared with 4.5% at end-2022 and 4.7% on average for peers. Problems will most likely arise for borrowers with preexisting weaknesses. We expect mortgage portfolios to remain resilient.

Related Criteria

• Sector And Industry Variables Updated For Europe Supplement Of Global RMBS Criteria, May 17, 2024
• RMBS: Global Methodology And Assumptions: Assessing Pools Of Residential Loans--Europe Supplement, April 4, 2024
• Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities, Dec. 22, 2020
• Methodology To Derive Stressed Interest Rates In Structured Finance, Oct. 18, 2019
• Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions, Jan. 30, 2019
• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 25, 2019
• Asset Isolation And Special-Purpose Entity Methodology, March 29, 2017
• Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• Principles Of Credit Ratings, Feb. 16, 2011
• Methodology For Servicer Risk Assessment, May 28, 2009

Related Research

• Banking Industry Country Risk Assessment: Portugal, Oct. 7, 2024
• European RMBS Index Report Q2 2024, Aug. 16, 2024
• Research Update: Portugal Upgraded To 'A-' On Ongoing Steep External And Government Deleveraging; Outlook Positive, March 1, 2024
• Economic Research: European Housing Markets: Better Days Ahead, July 17, 2024
• European Structured Finance Outlook 2024, Pushing On Through, Jan. 9, 2024
• Asset Price Risks: Inflated Property Values Mean Higher Loss Assumptions In European RMBS And Covered Bonds, March 21, 2022
• ESG Industry Report Card: Residential Mortgage-Backed Securities, March 31, 2021
• Residential Mortgage Market Outlooks Updated For 13 European Jurisdictions Following Revised Economic Forecasts, May 1, 2020
• 2017 EMEA RMBS Scenario And Sensitivity Analysis, July 6, 2017
• Global Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016
• European Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016