OREANDA-NEWS. The Italian government's new scheme to guarantee mortgages to specific types of borrower is unlikely to have a major impact on new lending volumes, Fitch Ratings says. It reduces the credit risk (and hence the capital requirements) of lending to targetted borrowers. But low demand from borrowers and cautious underwriting will continue to constrain growth in lending to fund new house purchases.

The Fondo Garanzia Prima Casa became operational at the end of January. It aims to support lending to borrowers who may not have sought, or been granted, access to credit since the financial crisis - chiefly first time buyers under 35 years of age. These borrowers accounted for just 21% of mortgage applications in 4Q14 according to bank credit information company CRIF. Under the scheme, the government will guarantee up to 50% of the loan balance of new mortgages with a maximum size of EUR250,000. The state guarantee means that loans made under the scheme absorb less capital.

The scheme also enables banks to recover the guaranteed portion of the loan 18 months after the borrower's default. This is a significant benefit in Italy, where the typical loan enforcement process is very long and uncertain. We estimate the legal recovery procedures on average take seven years. Our latest Italian Mortgage Market Index highlights that income from recovery activity in RMBS transactions is low, with period recoveries running at 5% of the outstanding defaults, while cumulative recoveries on all defaults to date stand at only 20%.

The guarantee scheme should encourage mortgage lending to first-time buyers in Italy, potentially at lower rates than were previously available, and we think it will be most useful to very small, regional lenders. These banks generally experience longer recovery times with more variable outcomes, due to their smaller and less efficient servicing operations. They may also find it harder to rebuild capital buffers compared to the bigger lenders.

Of Italy's most active mortgage lenders, Intesa SanPaolo, UniCredit, Banco Popolare, Credito Valtellinese are all participating and others may decide to do so. However, it is possible that banks will consider the operational burden of joining the scheme and administering it excessive for the relatively small potential increase in lending if they participate.

Indeed, feedback from lenders indicates that initial demand for partially guaranteed mortgages has been low. It may increase over time as awareness of the scheme grows. But low demand would be consistent with our view that borrower appetite for credit is limited, primarily due to labour market weakness (youth unemployment was 41.2% as of January 2015) and economic uncertainty caused by a prolonged recession.

Nor do we think lenders' risk appetite will grow or underwriting standards change as a result of the scheme. Banks are not designing new mortgage products to incorporate it and continue to target low-risk borrowers with relatively low loan-to-value ratios (below 50%), which will naturally exclude many first time buyers.

Bank of Italy data last month showed new residential mortgage originations in Italy increased 7.3% yoy in the first nine months of 2014, but this was largely due to refinancing activity. We think that new origination could increase by 5% yoy in 2015, but this will again be driven by refinancing of existing loans, which accounted for 36% of new originations in 4Q14, according to CRIF.

The scheme does not change our forecast that Italian house prices will fall further, by around 3% in the next two years, unless the economy picks up and restrictions on credit access ease further.