Mortgage covered bonds are one of the safest credit instruments in Turkey, according to Moody’s, owing to strengths including strong housing demand and effective legislation, although the rating agency said the product poses risks unique to the emerging market, as an analyst noted spreads have been subject to political volatility.

VakifBank on 26 April sold the first euro-denominated mortgage-backed covered bond from Turkey, a Eu500m five year issue. Bankers expect other Turkish issuers to follow VakifBank into the euro covered bond market, with another two or three benchmark issuances hoped for this year.

In a report published today (Friday), Moody’s noted that it has assigned all three Turkish mortgage covered bond programmes that it rates a rating of A3, which is three notches above the Turkish government rating.

The rating agency said “mortgage covered bonds are amongst the safest credit instruments in Turkey”.

Moody’s said Turkish mortgage covered bonds benefit from robust collateral, specific legislation that is aligned with those of the most developed jurisdictions, and proposed structured and currency protections that allows issuance denominated in foreign currencies to by rated as high as its local currency debt ceiling (A3).

The rating agency also said that residential mortgage loans are one of Turkish banks’ most creditworthy assets for several reasons:

• strong demand owing to a young and growing population with increasing disposable income that bolsters home prices;

• urbanisation trends and construction costs that sustain land prices in cities, keeping supply in check;

• and robust lending practices and macro-prudential measures that aim to insulate mortgage lending from crisis, while the low weight of mortgage lending in the financial system reduces the likelihood that a housing correction would spill into the financial system.

Moody’s said these strengths are borne out in the low non-performing loan (NPL) rate for mortgages, relative to other Turkish asset classes.

NPLs for residential mortgages and other Turkish bank loans

Source: Moody’s, Turkstat and Banking Regulation & Supervision Agency

Moody’s added that it expects house prices to cool in the coming years, but said it does not expect a drastic correction.

“The low weight of mortgage lending in the financial system, at about 6% of banks’ total balance sheets, reduces the likelihood that a housing correction would spill into the financial system,” added Tomás Rodríguez-Vigil, analyst at Moody’s.

The rating agency added, however, that Turkish covered bonds are subject to certain risks that are both unique to an emerging market and that apply to all covered bonds.

It cited the main risk posed to investors as stemming from tail-events related to Turkey’s position as an emerging market, with high susceptibility to event risk, a challenging environment for the country’s banks over the next 12 to 18 months – as the rating agency’s outlook for the Turkish banking system is negative – and banks’ heightened refinancing risk due to Turkey’s lack of a secondary mortgage market.

It also cited earthquake risks as having the potential to affect mortgage payment timing, with a significant portion of Turkey’s population and economic resources located in areas prone to seismic activity. However, it said a compulsory earthquake insurance system mitigates this risk.

“As it is virtually impossible to state with any relevant probability when and exactly where an earthquake may hit, we did not make any adjustment to the expected loss assumption,” Moody’s added.

“Furthermore, the issuer provided us with data following the earthquake in April 2009 in Aquila, and in reality most borrowers continued to repay their mortgage loans, despite not being able to live in their properties.”

Maureen Schuller, head of financials research at ING, noted this week that the spread of VakifBank’s debut has reflected volatility in other Turkish spreads in recent weeks.

Schuller said that after being priced at 250bp over mid-swaps, VakifBank’s deal quickly tightened to 225bp, mid, to trade through its nearest euro-denominated sovereign comparable, Turkey’s November 2021s.

However, she noted that after Turkey’s prime minister resigned at the beginning of May, the deal rapidly widened again in line with sovereign and bank senior spreads.

“Hence in light of the typically higher political/emerging market spread volatility we expect Turkish covered bonds to continue to trade aligned with underlying sovereign comparables,” added Schuller.

She nevertheless said that she expects there to be spread differentiation among Turkish issuers in the market once more euro benchmark covered bonds are issued, reflecting spread differences within the senior unsecured space.