Amendments to Turkish asset backed covered bond (ACB) legislation by the Capital Markets Board are a positive development that will help diversify banks’ funding sources, said Moody’s yesterday (Monday).

“As issuance of covered bonds in Turkey is in its infancy, the legal amendments are a favourable development for the banking system’s funding profile, which consists primarily of short term deposits,” it said.

Moody’s noted that these deposits, which account for 56% of balance sheets and with 85% maturing within three months as of the first half of 2011, constrain the development of longer term loans and their affordability.

“Further diversification into longer term funding sources will reduce the maturity mismatch between short term liabilities and long term assets,” said the rating agency. “Additionally, the reliance of covered bonds on on-balance sheet assets, for which credit risk remains with the issuing bank, encourages the banks to maintain sound risk management and lending practices as banks grow their loan books.”

The amendments were made on 20 July following the launch of the first Turkish covered bond, by Şekerbank, last month. This was launched under Turkey’s ACB legislation, rather than under another covered bond framework in the country, for mortgage backed bonds. Moody’s said the changes reflect contractual arrangements incorporated in the Şekerbank deal. (See here for previous coverage of Şekerbank’s transaction, and here for previous coverage of the revisions to the ACB framework.)

The rating agency said that the amendments are credit positive because they raise minimum overcollateralisation levels and mitigate commingling risk and a risk of servicing disruptions. Under the new rules, the minimum overcollateralisation was raised from a statutory obligation of 2% to 8%-46%, depending on the asset class.

“The new rule mitigates the risks that overcollateralisation levels will decline without remedy and that the issuer commingles the covered assets’ cashflows with its other assets,” said Moody’s.

Under the revised framework the cover pool monitor will ensure that the issuer deposits cash collections from the covered assets into a designated account for the benefit of investors – thereby preventing them from returning to the issuer – should overcollateralisation fall below agreed levels. If the breach continues for longer than one month, the issuer will redeem the ACBs early, using the accumulated cashflows.

Another amendment grants the Capital Markets Board (CMB) the right to appoint the Turkish Investor Protection Fund to administer any liquidation proceedings or manage the cover pool, if, for example, the issuer fails to fulfil its obligations and the value of the ACBs exceeds the value of the cover assets.

“The fund acts as a servicer of last resort and this partially mitigates the risk of disruption to the issuer’s servicing duties in the event of its insolvency,” said Moody’s.