A Capital Markets Board communiqué released last Tuesday unifies and improves Turkey’s mortgage and asset-backed covered bond laws, Moody’s said today (Monday), citing benefits such as better asset and liability matching,  reduced market risk, and better investor protection.

Moody’s said the new legislation is credit positive, and improves the two existing pieces of legislation. (See table below for a comparison of the previous and new legal frameworks.)

“The … legislation will enable issuers to better match cover pool assets with covered bond liabilities, reduce market risk and mitigate operational risks in case of issuer insolvency,” said Jose de León, senior vice president, Moody’s. “At the same time, the legislation will limit the issuance of covered bonds, which provides issuers with sufficient eligible assets to replenish their cover pools.”

CMB headquarters, Ankara

Improvements cited by Moody’s include the use of derivatives, which previously were only allowed to be an integral part of cover pools in the case of mortgage covered bonds and then only up to 15% of a cover pool’s net present value. Because the communiqué enables the use of derivatives, banks will be able to issue foreign currency covered bonds with greater ease and covered bondholders will be protected from currency risk, according to de León.

It also said that the legislation requires beneficial new stress tests aimed at protecting cover pool value against sharp fluctuations in currency exchange and interest rates, although “they do not sufficiently protect against potentially higher discount rates in the case of an asset fire sale where interest rates can widen by more than 300bp following an issuer default in an illiquid secondary loan market such as Turkey”.

Under the new unified covered bond legal framework, the cover pool monitor is responsible for stepping in to protect covered bondholders in the event of the issuer breaching a stress test, or breaching its payment obligations, according to de León. The rating agency noted that the cover pool administrator can manage the cover pool actively by selling the cover pool in full, in part or by arranging bridge financing that the cover assets will secure.

“The cover pool administrator can also sell the entire cover pool and transfer the covered bond obligation to another entity, or suggest the early amortisation of the covered bonds if it benefits the bondholders,” said de León.

The risk of disruption in the event of an issuer default is also reduced because the legislation allows the regulator to appoint other banks to manage the pool if it does not find a back-up servicer, he added.

The communiqué introduces an issuance limit, which means that issuers will have sufficient eligible assets to replenish cover pools, and that unsecured creditors’ interests are protected, according to de León. The issuance limit is 10% of an issuer’s total assets in the case of banks, and five times an issuer’s equity in the case of specialised mortgage lenders.

“These limits can be doubled for issuers rated A or higher,” said de León. “By having more eligible assets, issuers can more easily replace assets that become ineligible. If an issuer becomes insolvent, unsecured creditors would have recourse to a greater portion of the issuer’s assets that otherwise would be encumbered to covered bondholders.”

Source: Moody’s