A "payment holiday" scheme approved last week by the Italian Banking Association (ABI) is poised to negatively affect Italian residential mortgage-backed securities (RMBS), according to market commentary by Moody's Investors Service. The ABI's payment holiday initiative will grant payment relief for up to 12 months starting January 2010 to individuals that meet certain criteria. Moody's indicated this scheme is likely to negatively impact Italian RMBS unless it's adapted for securitization transactions. "Without proper implementation, certain deals -- especially those with low excess spread or no additional liquidity -- may potentially suffer downgrades, especially on junior notes, mainly due to an increased risk of back-loaded defaults," Moody's analysts wrote in commentary this week. As the scheme stands, borrowers must either have lost employment, receive temporary unemployment benefits, suffered the death of an income-producing family member or own a small business that has closed. Qualifying borrowers that meet any one of these requirements can suspend both interest and principal payments on their loan for 12 months. The effect of the payment holiday on Italian RMBS will vary depending on the number of participating banks, the portion  of the banks' securitized pools affected by the payment holiday, and the specific structure of the securitization transaction affected, according to Moody's. The ratings agency indicated borrower defaults may only be delayed rather than prevented, since loans in a payment holiday period may not be classified in arrears.  This may cause a back-loaded default situation in certain transactions when available excess spread is less readily available. "The overall impact of the payment holiday may still be positive, since it could reduce arrears and defaults in the transaction by giving borrowers more time to search for new employment, without defaulting on their mortgage loan," analysts wrote. "Given the current economic environment, however, it is reasonable to assume that this scheme may have a limited positive impact on transactions." The payment holiday scheme for individuals joins several mortgage-related consumer protection laws in Italy. The Bersani Decree eliminates penalty fees for prepaying certain mortgages, while the Tremonti Decree aims to encourage mortgage renegotiations into new fixed-rate mortgages with no upfront payment or fee. Moody's indicated the payment holiday scheme for individuals aims to ease the loan-servicing burdens of families severely impacted by the recession and is similar to the payment holiday scheme for small- to mid-sized enterprises (SMEs). The ABI said more than 500 financial institutions elected to participate in the scheme for SMEs, according to Moody's. The ratings agency said the massive take-up rate and large number of beneficiaries of the scheme will pressure the performance of Italian securitizations -- including RMBS and commercial MBS -- with exposure to SMEs. Under the scheme, eligible SMEs can, until June 2010, request a 12-month suspension of principal mortgage payments. The unpaid amount will be added to the end of the loan, in effect ending its maturity. To qualify, borrowers must be current as of Sept. 30, 2008, and must not be more than 180 days delinquent at the time of request. Moody's said financial institutions with outstanding securitization transactions would likely extend the suspension option to securitized borrowers, to avoid discrimination between them and non-securitized borrowers. The payment holiday presents four areas of concern that may negatively impact Italian CMBS and RMBS, including temporarily reduced collections, back-loaded defaults, structural concerns attached to swaps or triggers and increased performance volatility. Write to Diana Golobay.