New covered bond legislation has been proposed in Turkey that would unify the existing two laws and entail certain enhancements, according to Moody’s, which also highlighted reasons for expecting banks to start issuing mortgage backed covered bonds in 2014.

Three Turkish banks have issued covered bonds so far in recent years, doing so under asset backed covered bond legislation that provides for issuance backed by SME loans. The deals, issued by DenizBank, Sekerbank, and Yapi Kredi, were placed with supranational institutions such as the European Bank for Reconstruction & Development (EBRD).

Separate legislation exists for mortgage backed covered bonds, which several Turkish banks, such as Garanti Bank and Vakifbank, have been lining up to use, although no deals have been launched yet.

This is likely to change next year, however, according to Moody’s. In a special comment on Turkey focussing on the impacts on various sectors of the economy from any QE tapering, the rating agency on Monday said that it expects more Turkish banks will tap the covered bond market, targeting the more traditional European covered bond investor base, and that the first mortgage backed issuance is likely to take place next year.

Issuing more covered bonds will help Turkish banks close a growing funding gap and asset-liability maturity mismatching, according to José de León, senior vice president, Moody’s.

Mortgage lending is likely to continue to grow over the coming years as a consequence of demographics, increasing personal wealth and expanding urbanisation, he noted.

“We believe that Turkish banks will start issuing mortgage covered bonds as an additional instrument to close the growing maturity mismatch gap, which is even more apparent among mortgages relative to other types of assets,” he said. “The maturity mismatch is increasing because Turkish mortgage lending has an average maturity of 7.5 years, and also because banks are financing these loans with short term financial products.”

Turkish banks have also made progress establishing the necessary IT infrastructure and gathering sufficient eligible cover pool assets to potentially start issuing mortgage-backed covered bonds, according to de León. (Article continues below chart.)

Turkish banks’ maturity mismatch driven by funding mortgage loans with short term loans (June 2013)

Source: Moody’s, The Banks Association of Turkey

Two laws into one

The covered bond legal landscape in Turkey may also change, according to Moody’s. It said that in September 2013 the Turkish Capital Market Board released a consultation paper to unify the two existing pieces of legislation that govern asset-backed and mortgage covered bonds, respectively. A new law is proposed, which would entail certain enhancements of the existing framework, according to the rating agency.

One outcome of the amendments to the law would be clarification of certain aspects of how a cover pool administrator may manage the cover pool in case of insolvency, thereby reducing refinancing risks, said de León.

“The law also increases the over-collateralisation required for issuing mortgage covered bonds to 20% on a net-present-value basis from the current 2%,” he added.

The amended proposed legislation will also help banks issue foreign currency covered bonds with greater ease while ensuring adequate protection for covered bondholders from currency risk, he noted.

According to de León, the amendments achieve this by allowing derivatives, including foreign currency derivatives, to form an integral part of the cover pool, which had not been the case so far, for asset-backed covered bonds, and removing any limitation for the use of derivatives in mortgage covered bonds. Previously there was a limit of up to 15% of the cover pool’s net present value.

For mortgage covered bonds the new proposed law requires issuers to update property values once a year, similar to other developed covered bond jurisdictions, noted de León, with 75% and 50% the LTV cut-off for purposes of counting toward statutory tests for residential and commercial properties, respectively.

“As a result, in a scenario of house price depreciation, banks would need to add more performing assets to the cover pool,” he said.

Excluding NPLs from cover pools and updating property values is already market practice in Turkey for those banks that have issued SME-backed covered bonds, according to de León.

“In the three SME covered bonds we rate, the issuing entities have excluded NPLs (+90 days past due) from any cover pool calculation and imposed on themselves the requirement to substitute those loans with performing assets on an ongoing basis, similar to the market practice for most covered bond issuers in other jurisdictions,” he said. “We believe that this market practice can offer effective credit protection against increasing NPL trends and also against a potentially deteriorating credit environment.”

The Covered Bond Report was unable to reach the Capital Markets Board for comment.

For previous coverage of Turkish covered bond developments in The Covered Bond Report see here.