Securitization is one of the most important tools to finance a firm; therefore, its volume and importance has increased in last three decades. It is a financial tool to pool assets and turn them into tradable securities. In Turkey, securitization is still underdeveloped compared with European countries and the US. Even though it has a strong potential for the development of the securitization, it is still not at desired market levels. There are still obstacles and legal restrictions to be addressed. In this study, the securitization process in Turkey is examined and legal and regulatory obstacles related to the securitization are tried to be explained.
Asset Backed Securitization
Asset Backed Securities (ABS) or the securitization is the process of raising funds through issuance of marketable, liquid securities backed by original assets that the firm has already owned. In other words, securitization defines a creative way and result of converting regular, classifiable cash flows from a diversified pool of non-marketable existing or future assets of similar type, size and risk category into marketable, debt and equity obligations. It allows investor to improve its liquidity position without increasing in the balance sheet (Jobst, 2006).
Figure 1 Structure of securitization (www.usbankcortrusteeservices.com)
Securitization offers a number of benefits to the issuer:
enabling issuer improved marketable and more liquid assets,
connects financial markets and the capital market; thus, lowers agents intermediation cost through economic specialization,
greater investment flexibility through diversified securities,
securitization provides active and well-developed financial markets,
increases the pool of capital that can be lent by removing assets from balance sheet,
pooling and distributing financial assets provides investor to spread the risk,
offers highly customized asset classification to investors,
improves balance sheet liquidity by converting long-term and illiquid receivables into funds that can be used for additional value-generating investment,
All of those features are benefits of asset backed securitization but some results of securitization are not very bright as defined above in terms of accounting issues. The disadvantages of securitization are as follows:
Complex process-making the financial structure very complicated and requires legal expertise through whole process. It requires large scope of structuring so it may not be efficient for small-medium size firms.
Decreasing the balance sheet by making it smaller than its real value causes issues in accounting
Credit cycle problems make people borrow more than they should and causes regulatory problems.
Costs are associated with legal and management fees.
Bankruptcy: Market has experienced many such crises in the past where asset backed securitization played a role.
Securitization History in the World
Securitization started as a way for financial institutions and corporations to find new sources of funding either by moving assets off their balance sheets or by borrowing against them to refinance their origination at a fair market rate. It reduced their borrowing costs and in the case of banks, lowered regulatory minimum capital requirements.
International financial markets met new financial tools depending on developments that impact financial markets in 1970s. Those new financial tools or innovations appeared as noticeable developments in the market as forward, future, swap, option and asset backed securitization. Banker's deposits, bonds, equities and financial bills were the traditional financing resources until the beginning of the 1960s. New movements in international financial markets caused asset backed securitization to be an important tool instead of traditional investment banking applications in 1970s and 1980s.
Asset backed securitization began with the structured financing of mortgage pools in the 1970. Following that, the private sector began securitization in 1977. Any current or future cash flow that is generated by assets can be securitized:
mortgage loans
auto loans
credit card receivables
equipment leases
record album receivables
lottery winnings
Unsold airline tickets.
Financial Market Dynamics in Turkey
After financial crisis in 1970s financial reforms, liberalization and deregulation have been implemented along with political regulations. 1980s were the golden years in any area in Turkey and Turkish private and public sectors had undergone a number of regulations due to the global economy. The privatization program was initiated by the government to improve economic productivity through country. Those decisions led to make Turkish currency convertible and removed the restrictions on cash flow in and out of the country. As a result, foreign investments flow has increased by those initiative policies.
The stabilization program launched implementation under the Internationally Monetary Fund. Financial regulations followed in 1981 when restrictions on interest rates were removed. In 1984, foreign exchange trade was liberalized and resulted in reopening of Istanbul Stock Exchange. It was followed by open market operation in 1987. In 1989, regulations governing capital mobility by foreign investors were revised to allow non-residents to purchase securities under the premise of diversified portfolio investment versus direct foreign investment. In 1994, the Istanbul Golden exchange was opened as part of reorganization effort of Turkey's gold market. (Etkin and Helms.etc 2000)
Turkish financial market was hit by two crises in 1994 and 2001. The productive sectors of the economy were particularly harmed in an environment dominated by large movements of short-term capital, high interest rates, overvalued currency and a stagnant export market. The situation was worsened because the Turkish government was not disciplined enough and unable to meet its budget. It had to borrow from the domestic market with high interest rates. As a result, the economic policies in Turkey in the 1990s led the private sector to borrow from abroad and lend to the government. Investment for production was discouraged.
Turkey's financial market is principally dependent on the Istanbul Stock Exchange (ISE) - the sole stock or securities exchange in the country. This market has been marked with erratic economic growth and serious imbalances in the recent years due to the recent financial turmoil.
Securitization in Turkey
In 1992, the first asset-backed securities issuance was launched (Capital Markets Board Communiqué Series III, No.14, published in the Official Gazette 2499, of July 31th 1992). Capital markets law bill passed in 1992. Asset back securitization in Turkey does not have long historical background like other countries. Legislation comprises these institutions: banks, financial leasing companies and financial investment trust companies. It is required to have a bank guarantee from financial institutions except form banks in Turkey.
According to the capital market board, asset back issues should be based on:
Consumer credits: Loans are provided by banks for individuals as well as corporate entities
Receivables from mortgage
Receivables by financial lease agreements
Receivables due to the exports
Other receivables: receivables of joint stock corporations from sales represented by notes
Receivables from real estate investment companies
Small-size enterprise loans extended by special purpose state banks; and
Receivables of real estate investment companies represented by notes originating from real estate sales or option agreements.
Consumer loans or credits were not allowed after 1995 due to the inflation concerns. Receivables from exports and from agricultural cooperatives were included in 1995. Receivables against artisans and craftsman loans and consumer loans were included in the system in 1997. The rate of total issuance asset-value backed securities to total value exports has been 55% between 1992 and 1997. Those issues were very successful during that time.
It gained its strength with the Mortgage Law in 2007. The Mortgage law was passed on February 21th in 2007 and was offering a number of developments regarding foreclosure, consumer protection, capital markets and taxation. The law had two main objectives: to promote mortgage lending to individuals and to create secondary market for the originators since it has not gained desirables success for secondary market before (Standard& Poor's, 2007). Its aim is to enhance mortgage loaning and it also allows risks to be carried to the other parties who are willing to take them and increasing the funding for mortgages. The law also provides for the establishment of mortgage finance companies that can raise non-deposit funds and intermediate the securitization process (Turhan, 2008). The regulations for primary and secondary market also came with the law. Those regulations include the tax incentives, professional appraisers, and segregated securitized assets from issuer by the mortgage law. Banks, financial firms, mortgage finance corporations and financial intermediary institutions are empowered to be the founders. Fund board members are required to obtain license by capital market board. The structure was formed more into formal shape by the mortgage law.
Rating institutions have become mandatory for public issuers after the law and it also has brought internal auditor requirement.
With the Mortgage law receivable can be originating from;
Credit sales of joint stock firms
Credit cards, consumer loans, commercial mortgage loans and vehicle loans
Export transactions
Property sales of housing development Agency,
Other assets approved by Capital Market Board.
Checks and traveler's checks remittances;
Electronic remittance payments (generated primarily from Turkish and German workers); and
Diversified payments in the international financial markets.
It was a reform in terms of asset backed securitization progress. The previous law lacked of regulation thereby passing new law would provide desirable environment to apply asset-backed securitization in Turkey. With the new law interest rate decreased so the demand in housing increased. It brought transparency and liquidity hereby Turkey played an important role in the international market and financial market became more attractive for foreign investors.
Main objectives of the law are:
housing financing via capital markets
low interest rates and more affordable debt obligations
incensement in housing supply and restore construction industry
Launching new financial instruments to the market.
Turkish banks have securitized all those receivables by the law. The flow of transactions has provided long-term, lower-cost hard currency financing to banks in Turkey. Turkish banks with high-quality assets but lower ratings from credit rating agencies have been able to obtain cheaper funds through securitization than by borrowing from the money markets. The major banks involved in international asset securitization have become more liquid; thus, reducing risk and cost (Pekin et al .2008).
Future Flows Transaction
Future flow transactions are very common applications among the emerging markets in the world. In 2006, future flow transactions reached highest number with total issuance reaching nearly $5.8 billion. The future flow transactions have been backed by diversified payment rights (Standard& Poor 2007). Diversified payment right involves securitization of future payments orders. DPR usually take a form of either true sale structure or a secured loan structure. DPR deals the most common way of securitization in Turkey (Ferry, 2009). As it can be seen in Figure 2 after the global financial crisis numbers are dropping but still future flow transactions have survived in the time of financial turbulence.
Figure 2 Turkey's future flow issuance 2002-2009 (Standard and Poor's (2009))
Issues in Securitization
Even though existing assets transaction represent huge opportunity for asset backed securitization, certain areas related to the law are still not clear in the system. The Turkish mortgage system is underdeveloped and very new compared with other mortgage applications in the world.
The securitization issuance in Europe and the US are shown in table 1 and table 2. It can be seen that issuance volume has increased until 2008 and from that date it has little decrease in the volume due to the financial global crisis in 2008. The number shows that the usage of the securitization is very high in these countries.
Years
TOTAL2
Years
TOTAL1,2
2000
78.2
2000
1088
2001
152.6
2001
2308.4
2002
157.7
2002
2592.7
2003
217.3
2003
2914.5
2004
243.5
2004
1956.6
2005
327
2005
2650.6
2006
481
2006
2455.8
2007
453.7
2007
2147.1
2008
711.1
2008
933.6
2009
414.1
2009
1358.9
2010
107.1
2010
516.7
Table 1: Securitization issuance in Europe Table 2: Securitization issuance in the US
Source: www.europeansecuritization.com
All volumes are denominated in euro. The US volumes were converted from dollar to euro based on the $/€ exchange rates as of quarter-end.
Numbers may not add due to independent rounding. Historical or prior period numbers are revised to reflect changes in classification, refined selection methodology, or information submitted to our data source after the prior period cut-off dates.
The volume of securitization in Turkey is shown in Figure 3, as total amount of securities has grown in years, the asset backed securitization has decreased and have not been issued since 1998. Even though Mortgage bill has been enacted in 2007, it would not be an option to invest in market for the Turkish investors so far. Apparently, the enactment of the Mortgage law did not trigger increase in asset backed securitization in the market. It depends on several factors; thereby, those challenged should be taken into account to improve potential market in Turkey.
Years
Asset Backed Sec.(TL Thousand)
1992
14,481
1993
52,756
1994
42,299
1995
113,928
1996
41,629
1997
23,000
1998
11,000
1999
0
2000
0
2001
0
2002
0
2003
0
2004
0
2005
0
2006
0
2007
0
2008
0
2009
0
Table 3: Volume of Securitization in Turkey (www.cbm.gov.tr)
Challenges in the circulation are affecting the development of the securitization. This law or system has been adopted the application in other countries yet. It is believed that regulatory authorities still have to work on the adaptation process. It needs legal supportive environment in order to be achieved as a whole.
Sovereign Risk:
One of the biggest challenges that Turkey must overcome is its own rating (BB/Stable/B), which makes investment -grade level difficult. Rating a transaction above the sovereign refers that the underlying assets would keep performing even the sovereign has defaulted on its foreign currency obligations (Standard Poor's, 2007). The implications of the sovereign risks should be understood first. Sovereign risks are important factors in assigning ratings to the asset backed securities but it does not necessarily cap the asset backed securitization. Asset backed securitization transaction are subject to risks such as repatriation risk, inflation, currency devaluation transfer and convertibility risk and financial system risks.
Transfer and Convertibility Risk: The possibility of government restricting the ability to convert local currency into foreign currency and transferring it overseas is known as transfer and convertibility risk (Standard & Poor's 2006). Those limitations cause a default on securities and give no access for asset backed securitization environment. Turkey's T&C rating is 'BBB'-, so to mitigate risk further credit enhancement is required.
Legal Issues on true sale: The mortgage law recognizes true sales of receivables as the assignment of existing and future receivables. Moreover, an assignment will be an execution of a written agreement between assignor (in a securitization contract, the originator) and assignee (in a securitization contract, the special vehicle purposes) (Pekin and Borovali 2008).
Receivables originating from a contract might be assigned to a third party without permission of the debtor. In the absence of the debtor permission, it can discharge its obligation by making payment to the assignor directly. From that view, notifying obligors in writing of assets and receiving permission from the obligor should be main requirements in the system.
Bankruptcy: In general terms, Turkish law categorizes agreements into three groups in in term of the effects of bankruptcy:
Agreements that automatically terminate upon bankruptcy of one of the parties
Agreements that become subject to special agreements and regulations under the bankruptcy scheme
Agreements that continue to be valid.
There is no specific regime is set out under Turkish law for the assignment of receivables contracts. Therefore, in the event of the originator's bankruptcy, the assignment agreement will fall under the third party and will keep being valid and enforceable until the bankruptcy administration decides upon the fate of assignment agreement (Ozeke 2005).
There are no grounds for voiding the sale unless the assignee is aware of, or has acted together with the assignor in, a fraudulent transfer. Third parties cannot prevent the SPV from acquiring any of the future receivables and related collections as they are generated.
In the event of the originator's bankruptcy or receivership, any existing contract with the credit card companies is automatically terminated. The originator becomes unable to enter into a new contract with any credit card company that is free from the SPV's and/or trustee's claims.
According to Article 280 of the Execution and Bankruptcy Law (Law 2004), an assignment of receivables becomes null and void if the assignor makes it in the five years before its insolvency or bankruptcy with the intention of preventing the collection of claims by third-party creditors and the assignee is aware of this intention (Pekin and Boravali, 2008).
Re-characterization risk: A third part may declare that the party's real intention is to develop a security interest rather that transfer title under the securitization. Agreements of under this nature would null and void according to the Turkish law. Re-characterization risks exist and have huge effect in the event of bankruptcy. The purpose of the parties to transfer title into the assigned receivables outright and not merely to create a security interest, must be constituted as clear as possible to streamline risk and provide more secure environment (Guniz, 2006).
Regulatory: Neither purchase nor the servicing receivable are subject to have a license under the Turkish Law (Mayor and Brown, 2009). There are no restrictions on money transfers, currency exchanges, so those regulatory issues exist and create obstacles when they participate in cross -border transactions. There is no specific law or regulation governing offshore asset backed securitization. Developing a regulatory system under the law is vital to control over cross border transactions.
Political and Economic risks:
Volatility has been always a problem in emerging market Turkey has great potential for securitization in terms of its geopolitical position among its neighbors. Albeit this potential, it has to ensure political and macroeconomic stability.
Short maturities, high interest rates and resulting high monthly payments still may pose problems for securitization. Turkey should overcome those problems first before it will be fully successful to achieve asset backed securitization (Standard &Poor's 2007). Macroeconomic conditions such as 2001 and 2006 economic crisis have restricted mortgage originators. High inflation rate resulted in decreasing in purchasing power and people did not invest in any financial vehicle.
Political environment also should take into account for development of the securitization. Turkey still is suffering from Kurdish problem and it increases volatility in terms of political problems. Problems with Armenia and Cyprus also should be overcome for more political stable environment.
Conclusion
Turkey is an emerging market among its neighbors with its own dynamic structures and there is tremendous expectation in terms of asset backed securitization application by international rating institutions. The asset backed securitization in Turkey is mainly based on application in the US but there main distinctions between these countries in terms of financial system, tax advantages and regulatory environment. The United States has a role model for the other countries in the world therefore financial system and capital market are more comprehensive and regulatory institutions and financial intuitions are very developed.
The first asset-backed securities issuance was launched in 1992. Consumer loans or credits were not allowed after 1995 due to the inflation concerns. The rate of total issuance asset-value backed securities to total value exports has been 55% between 1992 and 1997. It gained its strength with the Mortgage Law in 2007.
The Turkish mortgage system is underdeveloped and very new compared with other mortgage applications in the world. As total amount of securities has grown in years, the asset backed securitization has decreased and have not been issued since 1998. The enactment of the Mortgage law did not trigger increase in asset backed securitization in the market.
Challenges of Turkey can be summarized as:
Sovereign Risk Problem
Transfer and Convertibility Risk
Legal Issues on true sale
Re-characterization risk
Regulatory
Political and Economic risks
Among these, most important problem is Political and Economic risks. Stable political and macroeconomic is a must for development of securitization changes should be made in legal environment. Implementation of legal regulations, improvement of servicing, political and economic stability and credit enhancements should be the areas that the government has to focus on. There is enough room in the market for those financial tools and Turkey could be very in a stronger position than other emerging countries. The government should optimize financial conditions and regulate legal framework.
