What is a covered bond? Covered bonds are corporate debt instruments secured or “covered” by cash flows mainly from mortgages or loans. They are similar in many ways to asset-backed securities in securitisation, but covered bond assets remain on the issuer’s balance sheet, and therefore, as a major advantage to the investors, covered bonds continue as obligations of the issuer.
Turkish legal framework
Turkish covered bonds are defined as capital markets instruments and named as covered securities, or covered bonds ("Teminatli Menkul Kiymetler (TMK)") under the legislation. The Turkish securities regulator, the Capital Markets Board (CMB), replaced the two pieces of communiqués on mortgage-covered bonds and asset-covered bonds, creating a single framework for both debt securities (the Communiqué on Covered Bonds (Series III-59.1). The Communiqué on Covered Bonds itself is based on the articles 13, 59 and 60 of the new Capital Markets Law No. 6362 which is effective since 30 December 2012.
Even though the Communiqué on Covered Bonds covers both asset- and mortgage- covered bonds, this article focuses on "mortgage-covered bonds" only.
Who is the issuer?
Covered bonds may be issued by housing finance institutions (konut finansmani kuruluslari) or mortgage finance institutions (ipotek finanmani kuruluslari).
Housing finance institutions are banks that are authorised to extend loans (or provide financial leasing) to consumers; and financial leasing companies and finance corporations authorised by the Turkish banking authority to perform housing finance activities.
There is not an issue limit at the issuance stage, but the nominal value of the covered bonds in circulation/trading at a given time and issued by non-mortgage finance institutions must not exceed 10% of the total assets of the issuer. If the issuer is a mortgage finance institution, the nominal value of the covered bonds in circulation/trading at a given time should not exceed five times of the equity of the issuer. These issue limits may be doubled based on certain conditions.
Shareholders resolution is required for the issuance of the covered bonds. However, the board of directors can also resolve to issue covered bonds if an explicit authority is given to the board of directors to issue debt instruments in the articles of association of the issuer. In either case, any such resolution (by the shareholders or the board of directors) should at least include a specific decision for the issuance of the covered bonds, the maximum issue size and sale method (e.g. offering in or outside of Turkey).
Application to CMB – regulatory approval
The issuers are required to apply to the CMB for approval to issue covered bonds, and the CMB must also approve the Turkish prospectus (izahname) if the covered bonds are to be offered to the public in Turkey and provide the required issuance certificate (ihraç belgesi) in any case, i.e. either public offering or private placement to local or international investors. If the issuer is a bank, the consent of the Turkish banking authority, or the BRSA, must also be obtained before the approval by the CMB. Covered bonds are required to be listed on Borsa Istanbul if they are offered to the public in Turkey.
Cover register (teminat defteri) is required to be constituted latest at the time of application to the CMB in case of a public offering. If it is a placement of covered bonds to local or international investors, the cover register must be concluded before the approval of the issuance certificate.
Apart from the assets that the CMB may further determine, mainly the following assets meet the eligibility criteria to form the pool of cover assets (teminat varliklar):
- Receivables of banks and finance corporations, arising from housing finance which have been secured by mortgage;
- Receivables arising from financial lease agreements entered into for housing finance;
- Mortgage secured receivables (or commercial loans) of the banks, financial leasing companies and finance corporations;
- Up to 15% of the net present value of the cover pool may be comprised of certain approved substitute assets which include among others cash and , Turkish government bonds.
Derivative contracts and swap counterparties – eligibility criteria
If derivative contracts are planned to be included in the cover pool, the issuer must ensure that there is a provision in the derivative contracts preventing the swap counterparty to terminate the derivative contracts in case of insolvency or bankruptcy of the issuer, and that the swap counterparty specifically approve inclusion of the derivative in the cover pool.
Level of overcollateralization
As mentioned below under the matching principles, the net present value of the cover pool must at all times be at least 2% more than the net present value of entire obligations of the covered bonds.
Protecting interests of investor
Turkish law provides protection to the investors in the event of issuer default and preserves the credit quality of the cover pool to avoid continuing deterioration before issuer insolvency.
Segregation of cover pool – mitigating commingling risk
Turkish covered bond issuers are obliged to maintain a cover register in a book or electronic form which will allow them to separately and privately record and observe the cover pool and the income generated from the cover pool, and to provide separate accounts or platform to allow daily review of the registration of any entry. Therefore, the cover register will permit the identification and thus segregation of the cover pool.
No encumbrance over the cover pool
Until the covered bonds are completely redeemed, assets in the cover pool cannot be disposed of, pledged, designated as collateral, attached by third parties, including for the collection of taxes or other public receivables, or cannot be subject to injunctive decisions of courts or included in the bankruptcy estate of the issuer. These restrictions apply even if the management or the supervision of the issuer is transferred to public institutions.
In case of partial or full default under the covered bonds, the cash flow generating from the cover pool is collected in a separate account of the issuer as of the default date and is used to repay due and payable obligations of the issuer against the investors. Cover pool monitor (teminat sorumlusu) is obliged to supervise and inform the issuer about these actions and whether the cover pool meets the total obligations.
If it is determined by the cover pool monitor that the above actions are fully or partly not complied with by the issuer, a written notification must be sent to the debtors of the cover pool that the monies/cash should be sent to a non-issuer account, or measures must be taken that are deemed as appropriate by the CMB. If the cover pool does not meet the obligations, investors can also recourse to the other assets of the issuer (ranking pari passu with unsecured creditors of the issuer) without waiting for collections under the cover pool.
Matching principles Nominal value matching
The nominal value of the cover pool may not be less than the nominal value of the covered bonds. While calculating the nominal value, the balance of the principal amounts of the loans, the issuance price of the discounted debt instruments, and the nominal value of the premium debt instruments shall be taken into consideration. Value of derivative contracts shall not be taken into account for nominal value matching.
Cash flow matching
The sum of interest, revenues and similar income that are expected to be generated from cover pool within one year following the calculation date shall not be less than the expected payment obligations under the covered bonds during the same period.
Net present value matching
The net present value of the cover pool must at all times be at least 2% more than the net present value of entire obligations of the covered bonds.
Coverage tests matching
The responsiveness of the net present value matching to the potential changes in interest rates and currency exchange rates shall be measured with monthly coverage tests. Mandatory overcollateralization amount should consist of substitute assets.
Cover pool monitor
It is mandatory for the issuer to appoint a cover pool monitor (teminat sorumlusu) which is selected among the independent audit companies that have the required CMB license to effectuate information systems audit in capital markets.
They are required to control the cover register and the cover pool in the cover register. They are specifically required to review the cover register, compliance of the cover pool with matching principles and accuracy of coverage tests.
Servicer and cash manager
The Issuers have the option, without any discharge to their responsibilities, to transfer duties for administration of the cover pool to a servicer (hizmet saglayici), and management of cash flow in relation to cover pool to a cash manager (nakit yöneticisi). Both the servicer and cash manager shall be appointed among the banks or mortgage finance institutions.