developing capital market solutions for the mortgage ......|1 contents need for a capital market...

Developing Capital Market Solutions for the Mortgage Market in Turkey

1|

Contents

▪ Need for a Capital Market solution for the mortgage market in Turkey

– How to ensure a long term sustainable growth of the Turkish mortgage market ?

– What are successful international examples ?

– Is there local and/or international appetite for investing in such a market ?

– Is the Turkish regulatory framework ready ?

– What have been, so far, the main hurdles ?

▪ Proposed Capital Market solutions and key economics

▪ Summary of results from first meetings with key stakeholders

▪ Proposed implementation roadmap

2|

Capital market solution approach for mortgage market in Turkey –Key messages

Need for capitalmarket solution

A secondary mortgage market is required due to funding deficit in near future and maturity mismatch risk of deposits and mortgages▪ Increasing loan-to-deposit ratio due to disproportionate growth in balance will result in funding deficit in

the near future – (in 2013 and later on)▪ More over, mortgages financed with short term deposits may lead to asset/liability incompatibility risk

1

Proposed capitalmarket solution

We are proposing a systematic solution for overcoming current obstacles in retail needs and kick-starting secondary mortgage market ▪ Current legislative framework in Turkey is compatible with most of the advanced standards and even

today allows issuance of both covered bonds (which are more favored by investors) and RMBS; however some hurdles are constraining these issuance activities: (i) no real need for additional funding (ii) available data related to mortgage (iii) long issuing process (iv) limited volume insufficient for covering issuing costs

▪ Although banks can issue covered bonds today, a central issuing entity (CIE) is proposed as a solution in order to develop a standardized and organized approach

▪ Establishing such a central entity (a lean pass-through organization) will enable both retail and multi originator issuances and this will lead to (i) decreasing process complexity (ii) creating volume (iii) creating a broader investor base and (iv) increasing reliability of market

2

Economicfeasibility

Issuing will be more attractive in specific market conditions especially when liquidity problems emerge▪ In current market conditions, covered bond economies within CIE are highly attractive (even today): 100

bps net yield and 200-220 bps additional yield by revaluing issuance revenues▪ These yields will become more attractive in a scenario where liquidity problems emerge

3

What we expect from stakeholders?

Participation of main stakeholders is important for kick-starting the market▪ Support of market players is a critical prerequisite for capital market solutions▪ Banks need to announce their participation, contribute to capital during CIE establishment process and

assign representatives for the steering committee▪ Just like the examples in foreign markets, participation of the government and some incentives are

supplementary elements in establishing and kick-starting mortgage market

4

3|

The need for a Capital Market solution for the Turkish mortgage market has been assessed under several angles – key questions

How to ensure a long term sustainable growth of the Turkish mortgage market ?

▪ How has been Turkish mortgage market growing compared to its peers? How is it expected to grow?

▪ How are assets/liabilities of Turkish banks developing? Can expected deposit growth sustain the increase in mortgage volumes?

▪ What would be the additional funding requirement for banking sector? What would be the volume potential of a secondary market?

What are successful international examples?

B

▪ What are the success stories of secondary mortgage market in the world? Are there any common themes among them?

▪ What are the roles of key stakeholders, government, banks, etc.?▪ How are the systems in successful countries running? What are the key

success factors?

Is there local and/or international appetite for investing in such a market ?

C

▪ What kind of investor base is required to kick start and sustainably develop this market?

▪ What do critical investors think about possible secondary mortgage market products issued in Turkey?

▪ Are there any possible concerns of investors? How can these concerns be addressed?

Is the Turkish regulatory framework ready ?

D

▪ Do the regulatory framework exist for governing primary and secondary mortgage market in Turkey?

▪ What are potential pitfalls or uncertainties in the law that would pose a threat in establishing the market?

What have been, so far, the main hurdles ?

▪ How did Şekerbank, the only covered bond issuance in Turkey, go in terms of process and timing?

▪ What should be done to overcome the main hurdles observed in Şekerbankissuance, problems observed in other examples and concerns of banks?

Two potential Capital Market solutions (i.e., “individual”solution and “system”solution) – not mutually exclusive – can be leveraged in order to develop a healthy secondary mortgage market

A

E

4|

Contents










5|

Residential mortgage lending in Turkey has significantly grown since 2005

26.419.817.418.0

11.97.81.30.5

+76%

3Q 2010

2009200820072006200520042003

Outstanding residential mortgage volume by banksEuro billion

Turkish housing sector has seen a major growth starting from 2005, under the boost provided by multiple factors, e.g.,

▪ Growing population

▪ Decreasing interest rates

▪ Increasing personal wealth

▪ Rising urbanization process

▪ Development of the legal framework on mortgages

Number of loans‘000

42 107 316 491 681 762 974

10.59.98.18.78.77.81.50.5

+54%

3Q 2010

2009200820072006200520042003

New residential mortgage inflows by banksEuro billion

Number of loans‘000

27 100 272 268 241 237 337

1,013

301

SOURCE: Banks Association of Turkey

6|

On the other hand, mortgages are still not the key source of financingfor housing growth

Turkey real estate sales between 2000-2010Billion TL

New mortgage sales

42%

09

67.7

32%

08

54.8

28%

07

46.9

33%

06

38.0

41%

05

33.1

39%

04

24.3

11%

2010

17.4

5%

02

14.8

2%

01 03

1%

2000

5.1

13%

75.9

CAGR1:31%

7.4

1 Inflation between 2000-2010 has been 15.5% on average per year

SOURCE : Banks Association of Turkey

7|

In fact many banks are financing residential housing with short-term financial products

0.4%0-1 years

7.5%1-3 years

5-10 years

27.9%

14.8%

3-5 years

10-15 years

46.1%

2.2%

20+ years 1.1%

15-20 years

0.4%

15.7%

2.0%

7.2%

0.9%

47.2%

26.6%

0.3%

1.9%

16.8%

0.8%

49.6%

24.4%

6.2%

0.4%

14.3%

6.8%

0.6%

48.4%

1.2%

28.3%

0.3%

14.0%

0.6%

52.6%

26.6%

5.7%

0.2%

0.5%

54.0%

0.5%

18.9%

21.9%

4.1%

0.1%

2006 2007 2008 2009 2010 2011 YTD

Total mort-gage sizeTL billions

22.1 30.7 37.3 42.7 57.6 68.6

Avg. mort-gage duration1

years 7.2 7.3 7.4 7.0 7.0 7.6

1 Based on original term duration of outstanding mortgages volumes; LTV can be at most 75% enforced by current regulation

35.8%

18.1%

34.2%

18.6%

30.9%

19.5%

35.5%

16.1%

32.5%

14.9%

26.1%

19.9%

SOURCE : TCMB

8|

Mortgage balance

Nominal GDP

Mortgagepenetration

Turkey will keep up with Eastern Europe’s

current level

▪ Real estate growth in Turkey (estimated to be over 10%) is driving mortgage growth

▪ Current maturity mismatch between mortgages (~7.5 years on average) and liabilities (~3 month on average) will grow more due to mortgage growth

x

Banking sector will be in need of a secondary mortgage market in near futureTL billion

Disproportionate balance growth which causes fundingdeficit will create need for alternative funding

Mortgage market in Turkey will continue growing rapidly and this will cause maturity mismatch between assets and liabilities to gain more importance

60

2020

450

2015

220

2010

2020

3,000

2015

1,950

2010

1,100

2020

16%

2015

11%

2010

5%1,007

872

135

4,500

4,000

400

Banking sector’s need for additional funding

A L

E

A L

E

▪ Estimated deposit growth with ~15% CAGR vs. credit growth with ~18% CAGR

▪ Level of equity is assumed to cover minimum capital efficiency ratio

2010 2020

Balance sheet of Turkish banking sector

-200

-150

-100

-50

0

50

2012 2020

1

-21 -14

-32-45

-71

-89 -90-80

-63-65

-90

-111

-146

-174-187 -190 -188

Additional funding requirementTL billion

▪ Additional funding will be required in 2013 –2014

▪ Crisis in Europe will increase the urgency

SOURCE : BRSA, ECB

9|

Outstanding mortgage volume trend is expected to follow Eastern European countries

▪ Turkey lags behind the Eastern European countries in mortgage penetration over GDP

▪ Mortgage penetration for Turkey has been simulated to come close to current Eastern European penetration by 2020

211918

1612

86544

201107 102002 03 04 05 06 08 09Poland

Czech Rep.

Hungary

Turkey

191919

111076432

2002 2011100803 04 05 06 07 09

17161715131210108

6

03 2011102002 0904 05 06 07 08

16

11

5

2

151005 20

DEMAND ANALYSIS

Outstanding mortgage volume penetration over GDP

Outstanding mortgage volume penetration projections

Percent

10|

Mortgage demand growth is also supported by estimated real estate sector projection

Housing transaction value

TL billions

45

56

67

+10% CAGR

2020

192

125

2015

121

65

2010

77

32

CAGR

21%

New mortgage penetrationPercent

41% 54% 65%

DEMAND ANALYSIS

Mortgage volumeissued

Methodology

▪ The breakdown of first hand, second hand and project stage housing sales are estimated

▪ Publically available data1 is used to calculate base market size

▪ Global Insight real estate growth are incorporated for projections

1 TÜİK, GYODER, Garanti Reidin, Global Insight databases are used

SOURCE: Global Insight, TBB, GYODER, TÜİK, Garanti Reidin

11|

We inserted our mortgage demand projections into the balance sheets and calculated additional funding requirement of banks in the futureTL billions

Assets

OFFER ANALYSIS

2020

4,545

15

2,422

10

1,007

2005

407

▪ Strong loan growth with even a stronger outstanding mortgage volume growth is expected, loan growth slows down after 2014

▪ Mortgage is the highest growth loan product with ~23% CAGR until 2020

Liabilities

2020

3,955

15

2,098

10

872

2005

352

▪ Deposit growth catches loan growth around 2015 with increasing wealth of the population and sophisticated banking products

Equity

Additional funding

402

213135

55

202015102005

▪ Equity is assumed to be keeping the capital adequecy ratio at minimum

▪ Scenario 1: Payables to other banks, money market and central bank keep its current 24% levels

▪ Scenario 2: Payables to other banks, money market and central bank increase up to 26% through higher levels of debt

-200

-150

-100

-50

0

50

Additional funding requirement

2012 2020

1-21 -14

-32-45

-71

-89 -90

Mortgage

Other loans

Securities

Other assetsOther liabilities

Deposits

-80-63-65

-90

-111

-146

-174-187 -190 -188

12|

More over, if economic conditions in Europe would deteriorate further, funding from foreign banks is likely to suffer and escalate the funding gap even worse

Declining volumes of bonds issuance from Eurozone1 banks …

… forcing the European Central Bank to steadily inject liquidity into the system

-12% p.a.

20112

473

2010

572

2009

616

ECB lending to peripheral Eurozone countries has increased in the year as GIIPS banks find it harder to access liquidity

€’bn

JulMar-11

SepMar-10

SepMar-09

SepMar-08

Italy

Spain

Portugal

Ireland

GreeceFacing stressed funding conditions, Euro banks are implementing hard measures:▪ Deleveraging of

less profitable businesses

▪ Holding positions (rather than growing) on more profitable and on strategic businesses

▪ Enforcing self-financing policies for any foreign subsidiary/activity

1 Eurozone includes all countries which use the currency Euro2 2011 numbers estimated by annualizing the bond issuances till 14th Dec 2011

SOURCE: Dealogic, European Central Bank (ECB); Central Banks of Countries, press clippings

13|

Hence, capital market solutions for mortgage market could become a tool to mitigate the liquidity concerns and funding gap

In order to support housing demand and mitigate the funding mismatchthere are two alternative (not mutallyexclusive) capital market solutions

Solution Description

▪ On-balance sheet instrument issued by the bank

▪ Off-balance sheet instruments issued by a SPV (Special Purpose Vehicle)

Covered bond

RMBS

Key features

▪ Covered bonds are issued by bank and have recourse, both to the cover pool and to the issuer

▪ Preferential claim of the covered bondholders against a dedicated pool of mortgage collateral (“cover pool”)

▪ Covered bonds are backed by a revolving/dynamic pool of qualifying collateral (credit quality and size, will drive over-collateralization requirements)

▪ Acquisition by the SPV of a pool of mortgage loans originated by a bank

▪ SPV finances the acquisition issuing mortgage backed securities to be placed with domestic and international investors

▪ Interest and principal payment to note-holders according to cash-flows generated by the underlying loans (typically non-recourse to originating bank)

Key benefits

▪ Additional source of liquidity to fund new mortgages origination

▪ Benefit from cheaper funding rates compared to more traditional funding sources

▪ Distribution of risk to a new investor base with consequent reduction of regulatory capital requirements (RMBS)

▪ Asset portfolio optimization

14|

Contents










15|

Multiple variations of covered bond and RMBS market models may be available for Turkey

▪ Limited and mainly local secondary market▪ Mortgage banks do not bear any substantial currency,

liquidity or interest rate risk

Why is relevant for Turkey?Examples explored

Covered bonds

Hybrid

RMBS

Danish model

Mexican adaptation

Malaysian model (Cagamas)

Italian (BCC) model

▪ Successful adaptation of Danish balance principle to RMBS products as well

▪ Recently, efforts in place to expand into covered bonds

▪ Flexible model between on- and off-balance sheet▪ Addressing both liquidity and risk management via

purchase with and without recourse, respectively

▪ Multi-originator scheme helps overcome small banks’scale hurdle

▪ Central solution to issue covered bonds▪ Government support at the start phase to create

covered bond market

French model

These models have been (in some cases) supported by regulatory incentives, especially in the initial phases

16|

Being one of the world’s largest covered bond markets, Denmark is considered to have a very robust mortgage system for over 2 centuries

Market participants

Investors

IssuersMortgage Banks

Telecommunication market

(OTC)

Reporttrades

Reporttrades

Book entry forum

Registration of trades

Copenhagen Stock Exchange

VP Securities Services

▪ Danish mortgage market is considered world’s most robust mortgage system with its 200 years of history and success during multiple world crisis

▪ 2nd largest covered bond market in EU after Germany

▪ Most of mortgages issues by Mortgage Banks, main lending operators

▪ Mortgage loan originators issue covered bond to finance their loans

▪ Covered bonds are issued and sold on a daily basis simultaneously with the fixing of final terms of granted loans (tap issuance). Final terms of granted loans are fixed within the terms of the issued covered bonds. Loans are not granted if mortgage banks can not obtain the relevant covered bond funding

▪ Covered bonds are traded in the Copenhagen Stock Exchange (OMX)

▪ Investors and issuers register their trades at VP Securities Services which provides technology to the whole system

Danish mortgage model

SOURCE: Nykredit; Danish Mortgage Bank Association, VP

17|

The Danish mortgage model is based on 3 main pillars (3-S)

1 That is, fixed rate loan, AMR, floating rate loans

1

2

3

Speed

▪ Mortgage Banks fund loans on a current basis, i.e. bonds are not sold until the loan is disbursed to the borrower

▪ As Mortgage Banks grant new loans daily, they also issue new bonds daily

▪ Simultaneous issuance of mortgage loans and covered bonds is called “tap issuance”

▪ The market price of bondsat the time of sale consequently determines the loan rate

Security

▪ Mortgage loans and covered bonds are matched for perfect balance of cash flows

▪ Borrowers are protected against market risk through the “Balance Principle”

▪ Borrower has always the option to prepay by– Buying the bonds at par– Buying the bonds from the

same ISIN at market price

Loan:5%

interest rate, 30-year term

Bonds:5% int-

erest rate, 30-year maturity

Standardization

▪ Supply of loan products is standardized, i.e. the borrower has a limited option of loans with predetermined loan type1, term, currency, amortization profile, etc.

▪ Uniform mortgage loans enable uniform covered bonds from same issuers with identical coupon, maturity, type of amortization for the same product type1

▪ These uniform bonds are grouped into the same International Securities Identification Number (ISIN) which is priced by the investors

▪ Supply of large quantities of uniform mortgage bonds ensures liquidity of the market, hence bonds are generally attractively priced by the market ensuring low interest rates for the borrowers

SOURCE: “The traditional Danish mortgage model” by Realkreditradet; LatinFinance

18|

Danish mortgage bond market has an efficient and effective operating model

1 Assuming credit underwriting process and scoring are already completed

Copenhagen Stock Exchange

Regular payments

▪ Borrower pays principal and coupon payments to the bank which transfers them to the investors

▪ Barrower pays commissionto the bank (usually 0.5% annually of the outstanding debt)

Prepayment

▪ Barrower has always the option to prepay by

– Buying bonds at par

– Buying bonds at market price

14

5

2

6

3

Bidding

▪ Investors bid on the bonds and the market determines the yield rate of bonds, hence interest rates of loans

Loan application

▪ Customers apply1 for mortgage loans specifying characteristics, such as maturity, coupon, etc. (example, 1 million DKKmortgage, 10 years maturity, 10% coupon rate)

6

1 5

3

Loan originate

▪ Loans are finalized based on market pricing

▪ Borrower receives cash

4

Bond issuance

▪ With tap issuance, bonds are issued same day

▪ Bonds corresponding to loans with same characteristics are grouped into ISINs

2

Borrowers Investors

Bank

Loan and bond issuance

Payments

SOURCE: Denmark Mortgage Bank Association

19|

Caisse de Refinancement l’Habitat (CRH) is a refinancing center for French banks’ mortgages

CRH bond issuances between 2000-10

Billion € Number of issuances

9.2

5.1

7.48.3

7.7

3.12.6

1.81.81.4

2.6

201009080706050403020120009 9 9 8 9 10 12 14 6 15 17

1 Until 1988

Background

▪ Created in 1985 by French government with State guarantee1 for refinancing of mortgages granted by French banking system

▪ Credit institution licensed to operate as a financial company by French Credit Institutions Committee

▪ Today, instead of state guarantee, very strong privilege to CRH’s bondholders on CRH’s secured loans to Banks

▪ Capital of CRH is owned by French banks▪ According to law, CRH needs to abide by capital

adequacy requirements▪ Capital adequacy ratio under Basel I and Basel II

is 8.67%▪ Capital stock is reallocated between banks

every year, on 31st March, so that banks have capital in proportion with their loans

▪ Banks have voting power in proportion with their shares in equity

SOURCE: CRH

20|

CRH is a lean organization with major French banks as its shareholders

Organization chart of CRH

2010

General Secretary

Finance and Communications

Administration and Accounting

Inspection

Members of these committees are

coming from founder banks

Board of Directors

Audit Committee

Compensation Committee

Chairman

In total 9 people is full-time employed at CRH

Breakdown of CRH equity

2011, Percent

Crédit Agricole SA – Crédit Lyonnais

Crédit Mutuel CIC

Société Générale

BNP Paribas

BPCE

Others

39.7%

35.2%

10.9%

8.7%

4.7%

0.8%

▪ CRH shareholders make up 90% of French mortgage market▪ Equity is allocated depending on the outstanding loans

Roles & responsibilities of shareholders

▪ Capital commitments – each bank must supply enough equity/subordinated loans to meet CRH capital adequacy requirements depending on its share of CRH loans

▪ Cash advances – Each stockholder must supply CRH with the amounts in the form of cash advances, required for its operation, subject to a limit of 5% of outstanding loans

▪ Board of directors – Each stockholder has a director in the CRHBoard with following key responsibilities– Setting maximum level, terms and conditions of bond issuances– Monitoring CRH activities, reviewing and approval of financial

reports

SOURCE: CRH

21|

There is an exact matching of CRH loans to banks and CRH bonds issued

CRH

Bondholders

Mortgageowners

Banks

▪ Refinanced loans constitute collaterals (with minimum 25% overcollateralization, 50% if floating rate1) for the notes Banks give to CRH in exchange for CRH loans

▪ Refinanced loans stay on the balance sheet of borrowing banks

▪ Loans pledged must at all times have an average life nearby to the residual life of principal note secured, and bear interest at an average rate equal to or higher than that on the note

▪ In case of insufficient collaterals due to refinancing of mortgage holder default, borrower bank needs to add enough collateral to the pool or buy enough bonds from the bondholders and deliver these bonds to CRH

▪ Only residential loans under 25 years and 1 million €

Bond issuance by CRH

CRH loans to banks

Mortgages to individuals

1

2

3

Value stream of key stakeholders Description

▪ CRH loans to banks have the same characteristics as those of CRH bonds, i.e. term and maturity perfectly match

▪ Substantially all of CRH bonds are issued at fixed interest rate

▪ Rated Aaa and AAA by Moody’s and Fitch▪ Repo eligible with European Central Bank and French

Central Bank

1 90% of mortgage loans in the market are fixed rate

Bond issuance

1

Loan issuance

2

Collaterals

3

SOURCE: CRH

22|

Effective recourse mechanisms and shareholder banks’responsibilities significantly reduces investor risk

Bank E(defaulted)

CRH

Investors

▪ Full ownership of collaterals is taken by CRH (Maturity dates,

mortgage notes lapses in favor of

CRH)

▪ If collateral insufficient, CRH has

recourse to defaulted bank as unsecured creditor

▪ Shareholder banks must immediately supply CRM with cash advance up to 5% of

outstanding loans to ensure timely payments

▪ If CRH experiences difficulty to satisfy the

claims of bondholders, shareholders are

required to allocate additional equity to CRH

▪ CRH has full responsibility to ensure

timely payments to bondholders

▪ In case of CRH voluntary or court-

ordered liquidation, capital contributions

(equity and subordinated loans) of

stakeholders are not repaid until all other creditors are paid in full

Bank A Bank B

Bank C Bank D

SOURCE: CRH

Credit risk is a risk on the French Banking System instead of

individual originators

23|

Mexico, as an emerging mortgage market, has succesfully adapted Danish model to RMBS

▪ Danish mortgage model is adapted to Mexico to improve access to mortgage financing and increase private homeownership in Mexico

▪ Soros Foundation and Danish Central Security Depositoryinitiated a company called HipotecariaTotal (HiTo) for this project

▪ VP Securities and Soros Foundation run Absalon Project to bring technology and consulting services

▪ HiTo’s mission is make the home financing mechanisms readily available to all the Mexican people by cutting down the funding costs of the Originators by providing technological systems, consulting, management, marketing in order to strengthen and facilitate the origination and issuance of covered bonds

▪ HiTo is a private company, and does not regulate, originate, promote or guarantee the Loans

▪ Danish model (“balance principle”) is applied to the RMBS market of Mexico

▪ Since its foundation, HiTo issued 100 million USD RMBS based on Danish model

SOURCE: SHF; The Economist; LatinFinance, VP

24|

Central solution (Hito) in Mexico enables also individual issuances utilizing all benefits of the system solution

From … … to

With simple interfaces and efficient integration of technology, small mortgage banks can access capital markets to fund their mortgage loans

continuously at low cost and high speed

7 months due to complexity

28 months due to scale

Mortgage banks (Sofoles) requests funding

SHF (Sociedad Hipotecaria Fund) gives funding

Sofoles grants mortgage loans and accumulates them

Securitization if market conditions permit

HiTo

Securitization

Large bank or Sofol

Small mortgage banks

Multi-sofol

securities

Theoretically 1 week, practically 1 quarter due to scale

Single-originator

securities

SOURCE: SHF

25|

Market context when Cagamas has been established

Market context

▪ Financial Institution faced tight liquidity situation in the mid 80s:

– Limited source of funding (deposits & equity)

– Funding mismatch –short term deposits to fund long-term housing loans

– Deteriorating loan to deposit ratio

– Inability to source for long term funding

▪ Limited private debt securities market

– Government main issuers of bonds

– Limited sources of long term funds

– Buy and hold practice by investors preventing active secondary trading

▪ Cagamas issued the first Islamic RMBS

1986 1987

▪ Launch of “Liquidity Model”: Purchase with Recourse (PWR)

▪ Cagamas started by purchasing housing loans from financial institutions on a “with recourse”basis ▪ Initially, only one product -

buying on fixed rate for 5 years with recourse

1 ▪ Launch of “Securitization model”: Purchase without Recourse (PWOR)

▪ Due to the change in market conditions (excess liquidity in banking system and low interest rates), the banks required, in addition to liquidity tool, the creation of a risk management tool

2

▪ Establishment of Cagamas. Main shareholders are– 20% Central Bank of Malaysia– 80% Commercial and

Investment Banks

2004 2005

SOURCE: Cagamas Berhad company report

26|

In the core of Malaysian capital market solution for mortgages lies on Cagamas

Business model

Structure

Mortgage originators

Investors

Purchase mortgages

with recourse

Proceeds from sales

Purchase mortgages

without recourse

Proceeds from sales

Cagamas

Asset ware-housing

Products

Debt security

RMBS

“Liquidity model”: Purchase with recourse (PWR) programme

“Securitization model”:

Purchase without recourse (PWOR) programme

Sell Cagamas bonds

Bond issuance proceeds

Sells ABS/ synthetic

securitization

SOURCE: “Mortgage Backed Securities Market in Malaysia” by Huang S. Chang, Cagamas Berhad company report

27|

BCCs have developed a transaction structure to issue RMBS on a frequent basis

▪ BCCs (credit cooperative banks), the Originators of the transaction, are local banks which support the local economy– More than 400 BCCs operate in

different regions of Italy (mostly in wealthier Northern regions)

– BCCs can only lend to people residing or businesses operation in their area of operation

▪ Credico Finance, the issuer, is a SPV pursuant purchase monetary claims in the context of securitisation transactions and to fund such purchase Law 130 with the sole purpose of by issuing asset backed securities or by other forms of limited recourse financing▪ The Portfolios purchased by the Issuer

comprise debt obligations arising out of residential mortgage loans classified as performing by the relevant Originator▪ In every transaction, each BCC sells a

portfolio of their mortgage loans to Credico Finance (credit risk is transferred to Credico Finance), who pools the purchased mortgages and securities the portfolio. Credico Finance issues– Class A notes that are sold to investors – Class B notes that are sold to BCCs▪ BCCs maintain the servicing on the

portfolios

Building blocks

Transaction diagram

Representative of noteholdersDeutsche Trustee Company Ltd

Operating bankICCREA Banca S.p.a.

SWAP counterpartyJPMorgan securities

Back-up servicesICCREA Banca S.p.a.

Limited recourse loan providerItalian Cooperative Bank

Class A notes

Class B notes

Retained by each seller bank

Collections P

urch

ase

pric

e

IssuerCredico Finance 9 S.r.l.

Originators and servicesItalian Cooperative Banks

SOURCE: Credico Finance 9 S.r.L Prospectus, DBRS Credico Finance 9 S.r.L rating report

28|

Mortgage issuance is practiced on a regional level

1 BCCs are non-profit oriented local banks, aimed at supporting families and businesses inside a defined area

▪ BCCs can only lend mortgage to people residing in their area of operation1, who make mortgage payments to respective bank’s portfolio

▪ Originator (BCC member) has its own characteristics and procedures of issuing loan, yet there are some common feautures across BCCs

▪ DBRS (rating agency) conducts operational risk review (do not rate individual originator) on large volume portfolios (44.85%) prior to securitization

BCC member A

Portfolio ARegion A

Client A1

Client A2

BCC member D

Portfolio DRegion D

Client D1

Client D2

………………………

Description Key implicationsHow it works

▪ Although originators do not have an exhaustive underwriting criteria, common credit-worthiness criteria analysis creates minimal differences in underwriting principles

▪ By reviewing underwriting procedures of banks which represent the largest proportion of the portfolio, DBRS is able to evaluate the risk in the portfolio

Mortgage loan

Loan payments


29|

Servicing is handled by originators and assisting banks

▪ Originators remain to be the servicer of the mortgage loan

▪ Originators transfer received mortgage payments to operating bank (ICCREABanca) on a daily basis

▪ Operating bank transfer the payments from originator mortgage portfolios to an Agent Bank (Deutsche Bank) every 15 days

▪ The agent bank pays coupon payment to bondholders (market and BCCs)

▪ Unless a triggering event occur (cross-collateralization), each BCC is paid its associated Class B tranche payment

▪ Issuer employs a swap counterparty (JP Morgan) to hedge against interest rate risk

▪ Allows CredicoFinance to act truly as a SPV

▪ Creates liquidity and excess cash to be invested for each acting bank, until transfer of funds

▪ Originators are bound to issue good mortgages as Class B Notes will not be payed in an event of delinquency (double check)

Operating bank

Description Key implicationsHow it works

Agent bank

Originator

Issuer

Class A Note Payments

Class B Note Payments

Retained by each seller bank


30|

Government support may help to kick start and sustain secondary mortgage market (1/2)

ReasonDefinition Examples

Capital requirements

▪ 0% risk weightingin capital efficiency ratio calculations

▪ Ability to hold these bonds by bank treasuries without capital requirements

▪ 0% in Malaysia ▪ Current RWA weight is in line with

Europe, however effectively disadvantageous because minimum capital efficiency ratio in Turkey is high

Government guarantee

▪ Government guarantee forpayment delay risks of banks

▪ Increasing reliability of new product and appetite of foreign investors

▪ Cagamas bonds in Malaysia▪ Implemented in the first stage of

CRH in France

Repo eligibility

▪ Eligibility of CIE’sPBs with TCMB’srepurchase agreements

▪ To help bank treasuries regard PBsas liquid tools

▪ common implementation (e.g., European Central Bank and Malaysia)

Tax advantages

▪ Tax allowance /benefits for covered bond revenues

▪ Making the issuance more economic by decreasing investors’expectations about margins

▪ VOB was supported with tax advantages in early stages

31|

Covered bond incentives may help to kick start and sustain secondary mortgage market (2/2)

Tax benefits

Stamp duty exemption

Withholding tax reduction

Required reserve ratio

Repo

▪ French CRH1 bonds and OF1: 10% risk weighting

▪ French OFH1 bonds: 20% risk weighting

Others (e.g. ECBpurchasing program)

▪ ECB purchasing program

▪ Government guarantee on covered bonds at the beginning

1 CRH: Caisse de Refinancement de l’Habitat; OF: Obligations Foncières; OFH: Obligation de Financement de l’Habitat; OBG: Obbligazioni BancarieGarantite

▪ German Pfandbriefe: 10% risk weighting (fully compliant with CRD and UCITS)


▪ Market making commitment by 17 institutions for Jumbo Pfandbriefeexceeding EUR 1bnin volume


▪ Italian OBG1:20% risk weighting

▪ Government support in establishment of a sustainable market (e.g., rating agency, auction system, information system)

▪ Risk weighting depen-dant on risk weight of the issuer. Minimum 10% maximum 100%


▪ Cagamas:0% risk weighting in Malaysia as they are recognized as liquid assets

▪ Turkish covered bond10% risk weighting1

SOURCE: Factiva, CRH 2010 Annual Report, firm’s website, European Covered Bonds Council

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Contents










33|

We talked to both local and international investors

Local investors

What they told us

International investors

Implications on Capital Market solution design

▪ Mortgage market is small, so currently banks can fund through shorter term financing

▪ Going forward maturity mismatch will pressurize banks

▪ Overall appetite

▪ Competitor banks would not buy single originator bonds, multi-originators preferred

▪ Competition

▪ Higher capital adequacy requirements▪ Capital benefit

▪ Stretch price Turkey covered bond 100 bps spread over normalized İtalian or Spanish covered bond before crisis


▪ Currency is still a concern▪ Real money investors would be

interested only if in Euro or USD denominated

▪ Currency risk

▪ Restrictions for portfolio allocation to securities other than sovereign bonds

▪ Investment limit

▪ Not repo-eligible in contrary to international benchmarks

▪ Cash flow management

▪ Delays (1 month or so) occur due to regulatory hurdles

▪ Regulatory hurdles

▪ Sustainable local investor demand

▪ None – Key requirements are more relaxed compared to other EU countries

▪ Joint-issuance through central solution

▪ None – Requirements are in line with European regulations

▪ Need for government/regulatory involvement (tbd)

▪ None – CMB is not the bottleneck

▪ Servicing mechanism

▪ Additional yield to investors to cover currency swap

▪ Mortgage loan is an anchor product, critical for customer retention

▪ Customer relationship

▪ None – CMB is not the bottleneck

SOURCE: Interviews

34|

Overall appetite – In the short/medium term, investments will mainly driven by bank and corporate treasuries

Local investor type

Mutual funds

▪ A&B type liquid funds established by bonds and intermediary companies

Description Asset breakdown

Asset under management

2010 20201

Life insurance and pension funds

▪ Funds established by private pension and life insurance companies

▪ Collected funds are ready to be invested to long-term instruments

P&C insurance

▪ Total assets insurance companies providing products apart from life(e.g., fire, motor, agriculture, etc.)

▪ P&C insurance companies manage their own assets

48

1218

62

Moneymarket

Stockexchange

Fixedincome19

Other

UK coveredbonds

34

6

9

2

55

Moneymarket

10Stockexchange

Fixedincome

35

22

Moneymarket

8

Stockexchange

Fixedincome

70

Other

UK coveredbonds

Other

Coveredbonds

1 Growth forecasts (19% CAGR for pension funds&insurance funds, 15% CAGR for mutual funds is estimated, 16% for institutional treasuries)2 Covered bond is assumed to have 25% of all private bonds held by institutions

0.7 - 1.0

0.1 - 0.3

0.1 - 0.2

Potential target size by 2020

UK example

15 – 16.5

Description

Banks

▪ Bank treasuries investing in different investment instruments to both actualize returns, match asset/liability maturity and balance capital adequacy ratio

Corporate treasures

▪ Corporate treasuries investing in different investment instruments to actualize return

153

34

20202010

62Privatebonds

38

Otherbonds

OtherCoveredbonds2

14 – 15

Total potentialby 2020

Real

mo

ne

y m

an

ag

ers

Insti

tuti

on

s

Asset under management (invested in local fixed income instruments)

Current private fixed income breakdown

Potential covered bondbreakdown

Bank and corporate treasuries have the highest potential to invest if they decide to increase

covered bond share in their total investments

Billion Euro

SOURCE: GBP, CMB, Undersecreteriat of treasury

35|

Investment limit – In terms of regulatory constraints on investments, Turkey is even more relaxed compared to other European countries

Investment limits of institutional investors on covered bonds

2525

55

20

N/A

7,5

Mutual funds

Pension funds

▪ There are specific legislations in Germany and Sweden limiting mutual funds’ investments on covered bond market

▪ For pension funds, Germany Pensionskassens have a 7,5% limit for ABS/CLN investments, whereas Sweden does not have any as long as covered bond risk matches the sovereign bond risk

▪ Turkey has no specific regulation for covered bond investments as it is not a well-developed instrument in Turkey and no rigid regulatory constraint is present from investment side

Key findingsPercent of total AuM

SOURCE: Regulations

36|

Capital benefit – Risk weighting of cover bonds in Turkey is aligned to Basel framework, but the minimum capital adequacy ratio is higher

Comparison of risk weights of sample assets used in capital adequacy calculation in Turkey and Basel II

Turkey Basel II

Cash

Government bond

Covered bond (MBS)

Mortgage loan

Assessment & conclusions

▪ Covered bond treatment in terms of RWA calculation for local investors is less strict than the international peers, as Basel II has not yet been implemented in Turkey (CB risk weight can go up to 100% depending on the ratings)

▪ On the other end, minimum capital adequacy ratio (CAR) is more strict in Turkish regulations compared to Basel II

12%1 8%2

50%

10%

0%

0%

Risk weighted assets

Percent

Minimum capital adequacy ratios

10%5

0%4

0%

35-50%3

1 Target ratio by BDDK, regulation enforces 8% 2 Will gradually rise to 10.5% by 20193 35% for LTV up to 80%

SOURCE: BDDK, “Bankaların Sermaye Yeterliliğinin Ölçülmesine ve Değerlendirilmesine İlişkin Yönetmeliği”, Basel II, CRD, European Central Bank

4 Depends on country rating, may go up to 150% if rated below B-5 Depends on covered bond and Bank rating

37|

Competition between banks could prevent some treasuries from investing directly to each others’ securities

“In the current competitive environment, a bank would never buy its competitors’ securities”

“Investing other’s securities would increase their ratings, why should we do that?”

Head of treasury of a bank


▪ Multi-originator system similar to Italy (BCC), France (CRH), Mexico (Hito), etc. would eliminate competition concerns

Potential mitigations

We can invest in covered bonds issued by other banks. We currently invest in other corporate bonds as well


SOURCE: Interviews, CMB

38|

Data requirements from Turkish regulatory body is slightly more relaxed compared to international benchmarks

▪ Contact details of issuer▪ Credit ratings issuer▪ Proof of eligibility of the issuer▪ Organization chart and financial reports for

last 5 years

Issuer information and contact details

Dimension

▪ Outline of the structure of the programme▪ Outline of 3rd party contractual agreements▪ Contingency plans in case of 3rd party default

Programme details

▪ Details of eligibility and replacement criteria▪ Asset pool management details▪ Scheme of internal processes (e.g. asset

segregation, cash flows, replacement plans, etc.)

▪ Stress tests on the asset pool and issuer

Asset pool details and management

▪ Credit rating reports▪ Prospectus and circular (if not private

placement)▪ Cover monitor/external reports on the pool▪ Internal audit report▪ Organization chart of asset pool management▪ Copy of documents related to stress testing▪ Copy of 2 most recent reports on covered

bond transactions

Documents

▪ Apart from a couple of mismatches, Turkish regulation is mostly aligned in terms of workload on issuer side – UK regulatory requirements are even tougher

▪ In Şekerbank VTMK issuance process, most of the documentation was required after the approval of application to speed up the process

▪ In line with VTMK issuance experience, current MBSlegislation is expected to be relaxed requiring all documentation after CMBapproval (private placement)

▪ In case of public issuance, all documents (additionally prospectus & circular) before registration and CMB evaluation will take longer

▪ In case of tap issuance, only cover monitor report and registration document is required by CMB 10 days before issuance

Requirements MBS VTMKCovered bonds

SOURCE: CMB, interviews, regulatory bodies

39|

Currency risk of TRL is a key consideration of international investors, which can be addressed by cross-currency swaps

“Currency is still a concern for us”

“TRL denominated bonds are only for local investors”

Global investment bank

Global investment bank

International investors are not willing to take TRL risk Swap market is growing in Turkey…

447432334

208118

17

2011120072006 201020092008

… although cross-currency swapyet to gain footholdPercent

Other

97

Cross-currency swap

3

Billion TL

1 Extrapolated for last 3 months

▪ For standard currency swaps with 3, 5 or 10 years maturity, there exists a liquid market

▪ Impact on overall product profitability to be assessed

SOURCE: Interviews, CMB

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Contents










41|

Is the Turkish regulatory framework ready ?

▪ Flexible interest rate options

▪ Prepayment option

▪ Appraisal

▪ Delinquency

Primary market Secondary market

Mortgage Law No: 5582MBS

Covered bond law(Serial: III, No: 33)

RMBSRMBS Law

(Serial III, No: 34)

▪ Offers sufficient framework for issuance

▪ Offers a safe investment environment for investors

▪ Compliant with EU standards

▪ Sets clear guidelines for issuing mortgage backed securities through SPVs

▪ Executes true sale and transfer of collateral under borrower consent

▪ Information disclosure methods are clearly described

Capital market lawNo: 2499

Bankruptcy and ForeclosureCode of Execution and Bankruptcy (No: 2004)

Borrower rightsConsumer Protection law (No: 4077)

▪ Turkey’s legal framework is mostly inline with that of our European counterparts

▪ For asset and liability management, minimum over-collateralization of 2% is lower than most peers and Turkey’s 2 week grace period practice is not common among our benchmarks

▪ Risk weighting rules are less stringent in terms of risk weight treatment of covered bonds

▪ Amendments pursuant to 5582 aim to kick start mortgage origination

42|

Amendments pursuant to 5582 aim to kick start mortgage origination

Areas of change

▪ Right to initiate execution proceedings parallel to foreclosure proceeding given borrower’s default

▪ Creditor may also choose to execute or foreclose

▪ Originator concerns due to lengthy foreclosure and execution processes are addressed by simplifying and shortening the process

Implications

Code of execution and bankruptcy law (No: 2004)

▪ Use of professional appraisers, licensed by CMB, during foreclosure process

▪ Variability in appraisals are addressed by streamlining the process

▪ Stringent liabilities to borrowers trying to delay the process (penalties1 for ungrounded claims to delay foreclosure proceedings)

▪ Shorter proceeding time

▪ Flexible payment plans for consumers ▪ Borrowers can choose between fixed or floating rate2 loan payments, with imposition of a 2% pre-payment penalty for fixed rate loans

Consumer protection law(No: 4077)

▪ Introducing grace period for consumers ▪ Acceleration right can only be exercised if borrower defaults on his payment obligations for 2 consecutive times (1 month grace period)

▪ Defining the liability of the borrower ▪ Originators are given a buffer as borrower is liable for the amount of the loan, not the value of the collateral

▪ Introduction of tax exemptions while originating mortgages and transferring them to cover pool

▪ MBS payments and issuer profits are subject to income tax

▪ House ownership is encouraged by exempting stamp, KDV and registry taxes in mortgage origination

▪ Mortgage payments are not income-tax deductable as in other countries

Tax changes(No: 5582)

1 Between 10-30% penalty2 With a cap on maximum mortgage rate

PRIMARY MARKET

SOURCE: Gide Lourette Mortgage Law report, TBB, TBMM, “Mortgage System and Contracts” by Murat Aydoğdu

43|

Structure of the issuer

1

Typical questions Key considerations

▪ Who is issuer?▪ Who owns assets?▪ Where to recourse?

▪ Universal and special credit institutions can issue covered bond with recourse

▪ Issuer does not have to be the originator of the mortgage, which allows a multi-originating platform

Asset and liability manage-ment

▪ How is market risk (e.g., interest rate, currency risks) mitigated?

▪ How is liquidity risk mitigated?

▪ What is the minimum over-collateralization?

▪ How are breaches addressed?

▪ Market risk (interest rate, currency) is hedged with derivatives, as assets and liabilities need not be matching

▪ Liquidity risk is addressed by matching bond payments and mortgage receivables

▪ Minimum over-collateralization of 2% is lower than most peers which is detrimental for bond security

▪ Breaches are given 2 week grace period in Turkey

3

Turkish legal framework satisfies key requirements on covered bond issuance (1/2) Aligned with

international standards

Partially not aligned with international standards

Cover assets

▪ Type of assets are included in cover pools

▪ What is the geographical scope of mortgage assets?

▪ What is the LTV limit?

▪ Mortgage loans originated in Turkey and substitute assets are allowed as cover assets which creates a simple and safe instrument

▪ LTV cap is inline with best practices

2

Alignment with international standards

SECONDARY MARKET

1 Senior RMBS can be included in cover pool in other countries

SOURCE: ECBC, CMB

44|

Turkish legal framework satisfies key requirements on covered bond issuance (2/2)

Cover monitor and banking supervision

4 ▪ Is there an independent cover monitor? What are his duties?

▪ What is the role of bank-ing supervision regarding covered bond (including in crisis situations)?

▪ Need for certified auditor/monitor▪ BDDK’s role as a supervising body is clearly stated and in-

line with international models. Yet responsibilities of governing body in-crisis situations must be clearly defined to address investors’ concerns

Segregation of assets and bankruptcy remoteness

▪ What is the legal framework in case of issuer’s bankruptcy?

▪ What is the cover pool?▪ How are bond holders

protected?

▪ Specific legal framework superseding the general insolvency law is in place similar to peers

▪ Only assets registered in the cover register (not total assets) are protected for investor which is optimal for issuers

▪ Receivables of debt holders of MBS are ranked more senior than government receivables

5

Risk weighting and comp-liance with European legislation

▪ Is the current system compliant with UCITS and CRD?

▪ MBS comply with the requirements of UCITS Directive as well as with those of the Capital Requirements Directive (CRD), therefore, they may qualify for a beneficial treatment under the CRD

▪ Covered bond treatment in terms of RWA calculation for local investors is less strict than the international peers, as Basel II has not yet been implemented in Turkey

6

Aligned with international standards

Partially not aligned with international standards

SECONDARY MARKET

SOURCE: ECBC, CMB

Typical questions Key considerations

Alignment with international standards

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46|

What have been so far the main hurdles?

Şekerbank VTMK issuance

▪ World’s first SME loan-backed covered bonds

▪ Significantly longer than similar transactions in EU

▪ Mainly internal processes and investor alignment took longer than normally expected

▪ Significant time spent with rating agencies to finalize ratings

▪ IT system development has been quite efficient

So far, in Turkey we had only a single comparable deal

Main hurdles

No real need of additional funding

1

Data availability on originated mortgages

2

Time lag between origination and securitization

3

Sufficient scale to cover originator costs

4

▪ Mortgage loan funding with existing sources so far

▪ Data supply difficulty due to nonstandard underwriting practices

▪ Long process due to internal inefficiencies and external negotiations with investors

▪ No scale justification to the issuance cost, esp. for smaller banks

Already discussed in the initial sections

Detailed in the following

47|

Şekerbank SME-loan backed covered bond issuance was the first example of individual issuance in Turkey which took significantly longer than similar transactions in EU

1 Time between first decision until issuance

Average issuance time1

Days

▪ Learning curve of Şekerbank– Determining eligibility criteria for cover

pool– Developing IT infrastructure– Creating first documentation

▪ First SME-loan backed covered bond in the world– Moody’s spent significant time to

determine rating procedure– Investors made repeated analyses to

understand the product and their internal evaluation and approval process took significant time

~100

~600

Key reasons for longer process

SOURCE: Interviews, press search

48|

2009 2010 2011

11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8

Cover monitor initial audit

Documentation preparation

Deal review by investors

Cover pool update

CMB evaluation

Final documentation to CMB

IT system development

Rating process

Determining eligibility criteria

Şekerbank ExCo decision

Covered bond issuance

Official CMBapplication

Start of initial preparation

~8 months

Execution(~8 months)

▪ Cover pool eligibility criteria is determined with investors (IFC, FMO and Unicredit) and Moody’s

▪ IT system development for systematic cover pool creation and to demonstrate cash flow segregation and no co-mingling

▪ Internal term sheet preparation and informing CMB

▪ Contacting BDDK for its advice

▪ Initial cover pool selection

▪ Documentation preparation with Unicredit

▪ Legal services from White&Caseand Verdi&Yazıcı

▪ Initial report from cover monitor (Ernst&Young)

▪ Review and fine-tuning of agreement/cover pool by investors

▪ Quarterly documentation update▪ Final documentation sent to CMB 5

days before the issuance and registration (ISIN generation, registration at MKK)

▪ Swap mechanisms by investors (3-5 days)

Cover pool creation(~4 months)

Mainly internal processes and investor alignment took longer than normally expected

Preparation(~8 months)

End of initial preparation

~8 months~8 months

SOURCE: Şekerbank interview

49|

▪ In our data survey, we asked data on portfolio characteristics, of which most are included in eligibility criteria

▪ We compared which banks responded clearly to these questions and which could not

Evidence demonstrating some banks are not ready to answer some typical questions regarding eligibility

Select Questions

Average LTV ratio of current portfolio

Payment schedules

Probability of default

Loss given default

Average value of collateral

Location of mortgages

Debt-to-income ratio

Annual income

Lo

an

ch

ara

cte

ris

tic

sP

rop

ert

y

ch

ara

cte

ris

tic

sB

orr

ow

er

ch

ara

cte

ris

tic

s

Bank 1 Bank 2 Bank 3 Bank 4 Bank 5

Approach

These two banks would have difficulty in preparing an eligible covered pool and get rating

before a comprehensive IT restructuring

Data availability – Survey results indicate that not all the banks are ready to meet the necessary IT infrastructure/database to issue a covered bond

Available

Partially available

Not available

2

SOURCE: Survey results

50|

Detailed next

Complexity – Effective solutions should be designed to remove risks associated with time-lag between origination and securitization

“Well-defined SLAs”

“Tap issuance”

Possible solution Description

▪ Originators may issue RMBS/covered bonds with a streamlined process based on past issuances at the original face value, maturity and coupon rates

▪ Hence, some process steps can be eliminated resulting in faster execution

▪ Defining internal SLAs regarding application preparation

▪ Defining SLAs for CMB to process application faster by removing some unnecessary, if any, steps

Key concern regarding complexity

▪ Longer time between origination and securitization puts market risk on the shoulders of originators

▪ Market risk is due to the changing market conditions at the time of origination and securitization

▪ Activities between origination and securitization has a considerable impact on originators’ resources

Both of these initiatives will require significant standardization

3

51|

International examples

▪ Sample issuances of mortgage-backed covered bonds in France

ISIN Date Issuer Face value Euro

Program amount Euro

Complexity – Tap issuance is a widely used method to eliminate some of the fixed cost items

1 Tap issuance is almost conducted in each issuance in Denmark and Sweden

Description

▪ Originators may sell RMBS/covered bonds based on part issues, at the original face value, maturity, and coupon rate

▪ Pricing is based on the current market conditions at the time of new issuance

▪ Fewer fixed cost items incurred by eliminating

– Certain legal cost

– Some transactions costs such as prospectus issuance

– New SPV establishment for RMBS issuance

▪ Extremely useful in case of small issuances

Implication for Turkey

▪ Percentage of covered bond supply through tap issuance in 2011 YTD1

7%Germany

Italy 9%

Spain 15%

UK 19%

France 21%

FR0011071299 21.Haz.11 Credit Mutuel Arkea Home Loan SFH 16.000.000 € 10.000.000.000 € FR0011035229 08.Nis.11 Credit Mutuel Arkea Covered Bonds SA 16.000.000 € 10.000.000.000 € FR0011053123 30.May.11 Credit Mutuel Arkea Home Loan SFH 10.000.000 € 10.000.000.000 € FR0011075969 01.Tem.11 Compagnie de Financement Foncier - CFF 24.500.000 € 125.000.000.000 € FR0011093541 09.Ağu.11 Compagnie de Financement Foncier - CFF 10.000.000 € 125.000.000.000 € FR0011099506 17.Ağu.11 Compagnie de Financement Foncier - CFF 15.000.000 € 125.000.000.000 € FR0011129006 30.Eyl.11 Compagnie de Financement Foncier - CFF 20.000.000 € 125.000.000.000 € FR0011131861 07.Eki.11 CIF Euromortgage 8.000.000 € 30.000.000.000 € FR0011136068 19.Eki.11 Compagnie de Financement Foncier - CFF 10.000.000 € 125.000.000.000 €

▪ Current regulation enables for originator use tap issuance – Bylaw on principles

regarding MBS, serial III, No. 33, article 26-4

– Bylaw on principles regarding Konut Finansmanı form and RMBS, serial III, No. 34, article 17

3

SOURCE: Danish Mortgage Bank Association; Investopedia; Dealogic; Financial Times

52|

Scale – Creating scale in capital market solution issuance is critical for achieving lower fixed cost per size while enabling market liquidity

Key concerns Proposed solutions

Fixed costs

▪ Securitization process incurs significant fixed costs such as application procedures, HR needs, SPV establishment for RMBS, etc.

▪ Since these costs does not change depending on the size of issuance, it is more desirable for originators to pool more mortgage loans together

Market liquidity

▪ Higher scale of issuances ensures liquidity of the market because investors can buy/sell the CBs/RMBS early from/to investors owning products of same issuance

▪ This increases attractiveness of product hence making it possible for originators to easier manage their spreads

Tap issuance

▪ Originators may sell RMBS/covered bonds based on past issues

▪ Fewer fixed cost items for each tap issuance

Multi-originator system

▪ RMBS/covered bond issuances may be based on the mortgage loans from multi-originators

▪ Fixed costs can be shared by a number of originators

▪ Positive impact on market liquidity

Standardi-zation

▪ Uniform bonds/securities of identical coupon, maturity, type of amortiza-tion make it easier to create scale of pools while reducing operational costs (e.g. documentation, rating processes, etc. )

4

53|

Scale – Fixed costs of securitization process are diluted in total costs with increasing scale

Return per issuance volumeMethodology

▪ Included cost items

– Placement fee

– Underwriter counsel

– Trustee counsel

– Rating

– Listing

– Marketing

– Loan audit

– Modelling time-out

▪ Breakdown analysis is based on

– Realized return of bank

– Volume issued in an issuance

384

0 100

Return of bankBps

Issuance volumeMillion TL

-445

Breakeven return

25

▪ Breakeven return is calculated assuming banks would at least get 20% IRR over their servicing expenditure

▪ As issuance volume increases, return of the bank increases as well

35

250

300

4

54|

Scale – Multi-originator systems are widely used in the world and as they can help to achieve effective scale for issuance

Capital market solution

Central unit(Platform) Operating modelCountry

France“CRH”

▪ Covered bond ▪ CRH(owned by French Banks)

▪ CRH gives loans to Banks, which propose mortgage loans as collateral, with a minimum 25% overcollateralization

▪ CRH issue bonds in the market and cash flows from the CRH loans to Banks perfectly match the issued bonds

Mexico “Hito”

▪ RMBS ▪ HiTo(owned by governmental bodies and private companies

▪ HiTo is an organizer that conducts RMBS auctions periodically

▪ Small-sized mortgage banks can have joint-issuance to address scale problems

Malaysia “Cagamas”

▪ RMBS▪ Covered bond

▪ Cagamas (owned by Central Bank and private banks)

▪ Cagamas purchase mortgage loans either with recourse (debt securities) or without recourse (RMBS) from different originators and sells securities to investors

Italy“BCC”

▪ RMBS ▪ Credico Finance

▪ Local Banks (BCC) sell a portfolio of their mortgage loans to Credico Finance, transferring also credit risk

▪ Portfolios are pooled and securitized

Spain“Cedulas TDA”

▪ Covered bond ▪ TDA(owned by private banks and JP Morgan)

▪ TDA collects covered bonds from individual banks and realize joint-issuance of covered bonds which are bought by investors

Co

vere

d b

on

dR

MB

SH

yb

rid

4

SOURCE: CRH, SHF, HiTo, Cagamas Berhad company report, Cagamas Berhad 2010 annual report, LatinFinance, Credico Finance 9 S.r.L Prospectus, DBRS Credico Finance 9 S.r.L rating report

55|

Scale – Standardization enables achieving higher scale of issuances while making it easier to pool mortgage loans

Benefits of standardization

▪ Supply of large quantities of uniform capital market products ensures market liquidity

▪ It is easier to pool uniform capital market products, hence it is possible to reduce some of operational steps/costs

▪ Easier to conduct tap issuance

▪ Easier to pool mortgage loans from multi-originators

Standard loan products

▪ Supply of loan product is standardized

▪ Borrower has a limited option of loans with predetermined

– Loan type

– Term

– Currency

– Amortization profile

In Denmark, fixed rate mortgageloans can have only 20 or 30 year duration

Covered bonds perfectly match associated loans, hence fixed rate bonds can also only have 20 or 30 years maturity

4

SOURCE: Danish Mortgage Bank Association

Standard bonds/securities

▪ Uniform covered bonds or RMBS with identical

– Coupon rate

– Maturity

– Amortization profile

56|

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57|

▪ Due to recent global crisis, covered bond is considered the most suitable solution in the short-term, as it keeps the credit risk with the originators unlike RMBS

▪ Current legislation enables the issuance of covered bonds, however there is a need for more organized and standardized approach to start-up the secondary mortgage market

▪ While every bank can, already today, issue covered bonds, to enable the organized and standardized approach, a central issuing entity (CIE) is proposed as a complementary solution

▪ In particular, CIE will be owned by Turkish banks willing to participate in secondary mortgage market

▪ Each individual bank will issue covered bonds which will bought by CIE and programme bonds will be issued backed by covered bonds from different banks

▪ This will ensure standardization and faster overcoming of learning curve, while providing large-scale market

▪ CIE will also enable the option of individual issuance through it, hence operational benefits of central solution will also be enjoyed by individual issuances

▪ Both individual and central solutions are economically justified, however central solution with more strict standards and additional utilities such as liquidity facility will receive better rating and higher spread for originator banks

Proposed Capital Market solutions – key messages

58|

Two possible non-conflicting methods are available in Turkey for implementation of capital market solutions

▪ CIE is a pass through lean organization with low fixed costs▪ Both individual needs of large banks and multi-originator

issuance of small banks (in order to solve volume hurdles) can be implemented via CIE

“Systematic”solution

Two non-conflicting

methods in implementation of

capital market solutions

“Individual”solution

Investor

(CIE)

59|

▪ Lack of standardization might require a very long review period by investors, and postpone their decisions

4

“Individual” solution – The main challenges will be to overcome learning curve and ensure standardization

▪ The main challenges for starting individual covered bond issuance will be– Data integrity– Standardization

▪ After the first attempts, learning curve might be overcome, but only in case of similar deals

▪ Hence, complexity of individual issuances will continue unless agreed upon common standards

Key learnings for individual MBS issuance

Description

IT system/data quality

▪ Developing necessary IT solutions (e.g. queries, database clean-ups) will be very quick as long as integrity and validity of data is ensured

▪ In case underwriting practices are not aligned to rating agencies’ expectations, one-to-one negotiations and reviewing of end-to-end processes will take longer

Investors

1

Process

▪ Internal and investor-related processes still not well-defined

▪ First issuance mostly through bootstrapping and navigating the processes

2

Documentation

▪ Documentation initially may take a lot of time mainly due to uncertainties of rating agencies and investors

▪ Streamlining internal processes, such as approvals, may reduce required efforts for documentation

3

CMB▪ CMB acts very quick and cooperative, hence

external/regulatory-related processes are not the bottleneck

5

Already today banks can issue their own covered bond programs

SOURCE: Interviews

60|

“System” solution has significant advantages over individual issuances

Banks

Investors

Key benefits Rationale

▪ Reducedcomplexity

▪ Standardization of issuance processes and covered bonds▪ No investor relation and road show effort on bank side▪ No individual rating hassle for banks▪ Centralized interaction with CMB through CIE

▪ Higher marketconfidence

▪ Clear guidelines & eligibility criteria leading to higher confidenceto products

▪ Streamlined approach

▪ Single touch point with the government solely focusing on MBSmarket

▪ Representation of all banks together before regulations

▪ Easier access and evaluation of standardized covered bond by local investors

▪ Resolution for competition concerns of large banks

▪ Broader localinvestor base

▪ More marketliquidity

▪ Frequent and large scale issuances through streamlined processes and aggregation

▪ Specialization ▪ Central guidance for banks through their internal processes▪ Share of know-how among banks

61|

Why we might need CIE

▪ Program bonds issued by CIE chould be more attractive both to local investors (no “competition effect”) and to informational investors (more standardized/transparent/reliable underlying)

Investor appetite

1

▪ CIE would allow banks to get additional funding and diversify funding sources (to cover liquidity needs) in a faster and more efficient wayQuick funding

2

▪ CIE should provide efficient and effective servicing to those banks willing to issue their own covered bondsServing/

outsourcing

3

▪ CIE would require banks to provide liquidity/market making (thus creating, possibly, a new source of business)New business

4

▪ CIE could enable a much healthier development of the mortgage market(i.e., standardization, transparency, ...)Healthy market

5

62|

Individual Turkish banks have comparable ratings

Issuer default risk

Long term rating

Senior unsecured rating

Ba3 N/A

N/A Ba1

Ba3 Ba1

Ba3 N/A

Ba3 N/A

Ba3 Ba1

Ba3 N/A

Ba3 Ba1

Ba3 Ba1

SOURCE: Bloomberg, Moody’s

63|

Two different structures can be used in establishing a central entity for covered bond and RMBS issuance of banks

1 TL 20 million

Current legal infrastructure

▪ Regulated by CMB law, clause no: 38/B

▪ No legal entity requirement and no obligations for capital (CMB Communiqué,

Serial 111 No:34, Article 4)

▪ Can be established by banks, financing companies and mortgage finance institutions (CMB Communiqué, Article 3, 5)

▪ Founder must launch a new fund and assign a fund committee (composed of 3 participants) before every issuance (CMB Communiqué, Article 6)

Covered bond issuance process

▪ Bank covered bonds take place in Housefinance Fund’s portfolio and RMBS is issued (CMB Communiqué, Article 20b)

RMBS issuance process

▪ Collateralized receivables are transfered to fund portfolio(CMB

Communiqué, Article 20a)

▪ Collateralized receivables are registered to General directorate of land registry on behalf of founderHouse

Finance Fund

Mortgage Finance

Institution

TOKİ’s non-collateralized real estate receivables can not be used for MBS and RMBS issuance

without an additional regulation

Limited capital requirement

▪ Regulated by CMB law, clause no: 39/A

▪ Related CMB Communiqué is still inproduction

▪ Its structure should be an incorporation with capital at least as much as1

development and investment banks

▪ Covered bonds purchased from bankscannot be used as a collateral for anothercovered bond due to :

– Bank covered bonds are not regarded as substitute assets according to Article 10 of current CMB Communiqué(Serial 111, No: 33)

– Substitute assets form max. 15% of total cover pool separately (CMB

Law, Article 13/A – not available in CMB Law draft – Communiqué 33,

Article 18)▪ Fund procurement to banks can be done

only if housing finance receivables and other assets are provided as guaranteeand covered bonds can be issued over these guarantees (CMB Law, Article 39/A; CMB Law draft, Article 60-4)

▪ Mortgage receivables are transferred to Mortgage Finance Institution and registered to General Directorate of land registry

▪ Mortgage Finance Institution launches a House Finance Fund for RMBSissuance (according to amendment in CMB Law draft Article 58.9, Mortgage Financial Institution may issue RMBSdirectly)

Minimum capital needed is same as bank/investment enterprise capital

need(min. TL 20 million)

SOURCE: CMB

64|

Tax liabilities may differ based on the status of new CIE and theyof issuance: covered bond or RMBS

1 Controversial. Treasury may claim BITT implementation 2 Controversial. Revenues from CB or mortgage loans and interest paid for RMBS are two different transactions thus can be regarded as BIT3 Effective when one of the signors is a fully amenable investor, not applicable when none of the parties is a fully amenable investor

Stakeholder Fees

CMB registration fee

Tax types

Corporate tax Withdrawal

Banking and Insurance Transaction Tax/Value Added Tax

▪ –

Bank

▪ CB: Exception▪ RMBS: Exception

if within the scope of house financing

▪ CB: Should be assessed like a bond; interests and valuation costs should be reported as expenditures

▪ RMBS: 20% ratio is valid in case of profit

▪ CB: No BITT because balance in favor is zero

▪ RMBS: If balance in favor, exception1 must be implemented

▪ Exception

Stamp tax (Revenue stamp)

▪ –Mortgage finance institution

▪ Exception▪ Used only in case of getting commission for brokerage

▪ Exception

House finance fund

▪ Exception▪ Exception ▪ – ▪ Exception

Limited taxpayer investors

▪ – ▪ –▪ – ▪ 0%: foreign companies and funds similar to Turkish companies and funds

▪ 10%: Real person investors

▪ –

Fully amenable investors

▪ – ▪ 0%: Banks, Turkish mutual funds and pension funds

▪ 10%: Real person investors

▪ For banks:– 5% BITT for

interest revenues– 1% BITT for capital

income▪ Exceptional

implementation for pension funds and mutual funds

▪ There shouldn’t be VAT

▪ – ▪ –

Cen

tral

En

titi

yIn

vesto

rs

▪ 0.005% over current net value of security assets

▪ Exception in scope of house financing

▪ Should not be implemented because balance in favor is zero2

▪ Does not occur if investment is not under the coverage of stamp tax3 (in case it is %0.825)

65|

Building blocks of proposed solutionBuilding block

Cover pool 3

Trigger events7

Servicing8

Form of Programme Bond

4

Cover monitoring 9

Description

Programme 1▪ CIE establishes a “programme” to refinance TL denominated Covered Bonds issued by CIE shareholders

(“CB”) through the issuance of TL denominated programme bonds (“PB”) ▪ Each Originator Bank issues CB in series, made of same coupon, payment date and maturity ▪ Each CBs of a specific series are associated to a correspondent PB issued by CIE

▪ Cover pools are made of residential housing loans compliant to eligibility criteria, e.g., type of loans, maximum amount, maximum residual terms

▪ Collateral of PBs are CB issued by Originators Banks

“Issuer”2▪ “Central issuing entity” (“CIE”) is a master trust with limited liability▪ Equity of CIE is owned by main Turkish banks but CIE is independent from shareholders banks ▪ CIE is managed by a special purpose management company with limited liability and under the supervision of

CMB

Rating10▪ Fitch's rating approach to multi-issuer covered bonds is based on (i) strength of the Originators Banks, (ii) quality

of the Cover Pools, (iii) obligor Concentration and (iv) default probability of the rated notes ▪ Existence of “country ceiling” to be further investigated

Liquidity facility5▪ The liquidity facility must be sufficient to cover the interest payments on PBs for at least [••••] year(s) in case of

default of CBs issuer

▪ The programme is cancelled and CIE liquidated in case “termination trigger” happens

▪ CB issuers are responsible for setting up a cash deposit if OC falls below [•]% (“OC trigger”)

▪ Servicing activity will be carried out by the originating banks▪ CIE appoint a Turkish entity as backup servicer to step-in in case a “servicer event” occurs (e.g., the servicer fails

to provide monthly report)

▪ The programme issues fixed-rate PB (floating-rate bonds to be discussed)

▪ Type of amortization of PB is bullet (amortizing bonds to be discussed)

▪ CIE is appointed of the supervision of the Originator Banks’ obligations in respect of the cover pool

Waterfall of payments

6▪ Priority of payments is sequential

Detailed in the next pages

66|

Merkezi İhraç Kurumu (CIE) bankalar ve piyasa arasında bir servis sağlayıcı ve aracı olacaktır

Diğer varlıklar Öz sermaye

İpotekli tahvil Banka 1

“Merkezi İhraç Kurumu - CIE”

Teminat varlıkları


OC

OC

İpotekli tahvilBanka 1

Katılımcı banka 1

İpotekli tahvilBanka 2

Katılımcı banka 2 CIEPBleri

Merkezi ihraçkurumu (CIE) program tahvilleri (PB) seri I

Seri ihracı

Yatırımcılar

CIE PB seri II

CIE PB seri III

İpotekli tahvil Banka 2

Likidite kuruluşu


OC

İpotekli tahvil

Diğer kurumlar

İpotekli tahvil …

▪ CIE, teminat havuzunu ve ihraçstandartlarınıbelirler (örn: derecelendirme kuruluşlarıyla uygunluk kriterlerini belirlemek)

▪ Bankalar mortgage’adayalı ipotekli tahviller ihraç eder

▪ CIE bu ipotekli tahvilleri kendi program tahvillerine (PB) teminat olarak satın alır

▪ CIE, katılımcıbankaların mülkiyetindeki yalın bir organizasyondur

1

67|

Preliminary investigations demonstrate that CIE could work bothfor “Programme Bonds” and “CIE RMBS”

Approach

▪ “Programme Bonds” and “CIERMBS” can be issued by 2 dedicated “house finance fund” in order to “segregate”the different under-lying asset pools

▪ Issuance can beexecuted by a “Central Issuing Platform”

▪ Management company for both funds could be the same

Potential structure of “Central Issuing Entity” (CIE)

CIE management company

Central Issuing Entity for Programme Bonds

Central Issuing Entity for RMBS

Central Issuing Entity (CIE)

Key points to be investigated on “CIE RMBS” origination

In RMBS, assets are transferred by banks to CIE as “true sale” transactions. This implies that CIE:

▪ Assume direct risk on mortgage assets with no recourse to selling bank

▪ Gets ownership of the mortgage and therefore is responsible for servicingthem (but this could be delegated to bank themselves)

▪ Has to provide hedging for interest rate and currency

Finance Funds

1

68|

Diagram of cash-flows of the solution

Investors

Interest on PB

Principal on PB

Proceeds

CB 1

CB 2

CB n

Cover pool 1

Cover pool 2

Cover pool n

CIE

Programme Bond Single bank Covered Bond

▪ No possible mismatch within CIE

▪ structure because the fix/floating-rate PB are collateralized by a set of fix/floating CBs that pays same amount on the same date with same amortization scheduling

▪ CIE will be able also to draw on a liquidity facility to meet any interest payment shortfalls on PB in the event of a single CB’s default

▪ Possible mismatch between:

– Cash inflows from mortgages and cash outflows to CIE

– Interest rates as the features of the coupon of single CB could be completely independent from interest rate of cover pool

▪ If significant, the cash-flows mismatch must be managed by each Issuer trough ALM, as already done by French banks participating to CRH program or Spanish banks participating to Multi-Cedulas program

Interest on CBs

Principal on CBs

Proceeds

Interest rate on mortgages

1

69|

Example of a program structure

Description

▪ CIE establishes a “programme” to refinance TL denominated Covered Bonds issued by CIEshareholders (“CB”) through the issuance of TL denominated PBs

▪ The programme could include the participation of any of the shareholders financial institutions

Key elements Description

Programme size

▪ Programme size is up to [•] billion of TL outstanding ▪ Programme limit may be increased in accordance to shareholders agreement

Issuance in series

▪ Each Originator Banks issues CB in series; series are made of residential mortgages with same coupon, payment date and maturity

▪ Each CBs of a specific series are associated to correspondent PBs of the series, issued by CIE(CIE, as master trust, allows to sell multiple series of PBs from the same trust)

▪ PBs of each series are collateralized by all CBs of the series: additional CBs are fungible with the existing ones

▪ In case of tap issuance on existing series:– Originator Banks tap issue CBs; as a consequence – CIE issues PBs of same series for an amount equal to tap issuance

▪ In case of issuance of new series:– Originator Banks issue CBs; as a consequence – CIE issues PBs of new series for an amount equal to new issuance

Maturity date▪ The programme will end on Dec 31, [•]▪ The maturity of each series will be up to [•] years

Issue price▪ Covered Bonds will be issued on a fully-paid basis

1

70|

Potential solution for breakdown of CIEequity

Issuer – “Central Issuing Entity”2

“Pro-rata”

▪ CIE equity is divided within participating borrowing banks, according to their local market share

“Equal share”

▪ CIE equity is divided within participating borrowing banks on an per-capita basis

▪ Central Issuing Entity (CIE) is a “pass-through” master trust with limited liability, specifically established according to the laws of Turkey

▪ Equity of CIE is owned by main Turkish banks,but CIE is independent from them (bankruptcy proceedings or liquidations of banks, holding CIEequity, cannot be extended to CIE)

▪ CIE will be structurally similar to “KonutFinansmanı Fonu”, however with possible exceptions to its role, activities, and issuances

▪ CIE does not borrow for its own account but on behalf of banks and does not charge any interest on its refinancing activities

▪ CIE will be managed by a special purpose management company with limited liability under supervision of CMB. OPEX of the management company will be paid adding a margin of [••••] bps on CBs interest rates

Description

71|

Cover pools3

Eligibility criteria Description

Type of eligible loans

▪ Residential housing loans with, e.g.– First rank lien– LTV lower than 80%, calculated based on independent appraiser valuation– Insurance against fire and earthquake for the entire term of the loan– Collateral within geographical boundaries of Turkish Republic and with “habitation

certificate”

Maximum residual terms of eligible loan

▪ Less than [••••] years (preliminary hypothesis could be 30-years)

Maximum amount of eligible loan

▪ Less than TL [••••] of capital remaining due (preliminary hypothesis could be less than 1÷1,5 million Turkish Lira)

Over-collateralization▪ Minimum [••••]% (preliminary hypothesis could be more than 125%)

No pre-payment risk▪ If loans of cover pool are repaid, borrower bank should replace them in the cover pool

Concentration

▪ No single debtor shall represent more than [••••] % of the total principal amountoutstanding of the claims

▪ Largest [••••] debtors shall not represent more than [••••] % of the total principal amountoutstanding of the claims

▪ Largest [••••] debtors located in low GDP Turkish regions shall not represent more than [•]% of the total principal amount outstanding of the claims

72|

100

30272523

20

24

30

22

27

20

25

18

23

16

20

Amortizing bond Bullet bond

Mortgage payments happen on a monthly basis, rather than yearly basis; hence there is a need for reserving and investing monthly mortgage payments to match annual/semi-annual CB payments

Part of mortgage payment must be reserved and invested at a minimum interest rate at 10% to cover bullet payment, which might cause interest rate risk

Over-collatera-lization

To be reserved for bullet payment

Years

26

1

10

2 3 4 5Bank

Over-collatera-lization by 25%

Years

Monthly mortgage paymentreceived

Covered bond coupon

payment (typically

quarterly or semi

annually)

26

1 2 3 4 5

26 26 26 26 26

3333 33 33 33 3333 33 33 33

Bank

Monthly mortgage paymentreceived

Covered bond coupon

payment (typically

quarterly or semi

annually)

Banks need track and separately manage cover pools to match the cash flows of covered bonds100 per value, 10% interest rate, 25% over collateralization

Principal payment

Interest payment

▪ Cash inflows are not always a constant due to portfolio structure, prepayment, delinquency etc.

▪ Overcollateralization supplies enough buffer to overcome these issues

4

▪ Bullet vs amortizing profile will be investor-driven

▪ Bank treasuries will be responsible for ALM in case of cash flow mismatch

▪ Interest rate swap can be leveraged to mitigate timing mismatches between cash flows

73|

Description

Liquidity facility5

▪ The programme is able to draw a liquidity facility to meet:– Any interest payment shortfalls on the PBs for at least [•] year(s), in case of

default of a CB’s

– Any extraordinary expenses up to an equivalent of [•]% of the defaulted amount

▪ CIE enters into a liquidity facility agreements with the liquidity provider(s) in order to ensure the appropriate liquidity support in the event of CBs defaulting

▪ Each series has its own specific credit limit within the liquidity facility, which is defined prior to any new or tap issuance, and must be in line with Rating Agency criteria under stress scenario associated to the rating of PBs

74|

Waterfall of payments6

3. Remuneration of the liquidity facility

1. Expenses, taxes and general costs

2. Interest accrued on the bonds

5. Principal on the bonds

4. Reimbursement of the liquidity facility

6. Any excess proceeds to Originators (once PB is liquidated)

75|

Assigning RatingsTest available OC at all CB Issuers

Rating of each series of programme bond10

▪ Fitch's rating approach to multi-issuer covered bonds is based on 4 pillars:– Strength of the

Originators Banks– Quality of the

Cover Pools– Obligor

Concentration– Default probability

of the rated notesdue to not timely receipt of interest and not full redeem of principal by final maturity date

▪ Fitch has defined a 3-steps rating processfor multi-issuer covered bonds

Description

Extract from FitchRatings methodologies

Test Liquidity Facility

▪ This output is used to assess whether the liquidity facility can support interest payments during a one-year periodon the portion of the CB portfolio that is assumed to default in the relevant rating scenario

▪ This output is used to test if the available collateralization supports a recovery rate of 100% in the event of a CB default

▪ Fitch estimates the cover pool expected losses due to credit risk and liquidity risk:‒ The credit losses

are applied to the full cover pool

‒ The surviving (non-defaulted) amount is subjected to a liquidity risk loss applied in the form of an additional haircut on the cover pool's face value

▪ The rating assigned to the PB seriesaddresses both timely interest and ultimate principal payments at the target stress scenario

▪ For example, if the transaction provides for timely interest payments in a “AAA” scenario but the collateralisation in place can only support 100% recoveries in the “AA” scenario, the transaction's maximum achievable rating would be “AA”

1 2 3

SOURCE: FitchRatings

76|

Covered bonds are higher rated and sold at lower yields compared to senior unsecured bonds by Banks – France example

5-year maturity 10-year maturity 12-year maturity

Issue date Rating YieldCompany Issue date Rating YieldCompany Issue date Rating YieldCompany

22.04.2010 AAA 2.60

22.04.2010 NR 3.34

08.11.2010 AAA 2.91

21.10.2010 A+ 3.95

06.01.2011 AAA 3.77

21.02.2011 A+ 5.32

07.06.2010 AAA 3.78

16.06.2010 NR 5.72

30.08.2011 AAA 3.91

22.09.2011 A+ 5.22

10.10.2011 AAA 4.02

04.11.2011 NR 4.39

15.02.2011 AAA 3.96

17.01.2011 NR 5.96

10

SOURCE: Bloomberg

77|

Key economics – the covered bond return has been estimated net of all issuance costs

Analysis items

Total return

Return from proceeds

Return from issuance

Investor yield

Net returnof bank

Bank costs

Bank returnfrom covered pool

Explanation

▪ Interest rate paid by borrowers – total revenue coming from mortgage pool

▪ Costs associated to servicing of mortgages, cost of capital, cost of risk, required reserves and CB issuance

▪ Return of bank after its internal costs

▪ Residual left to bank from the transaction

▪ Average return of bank from the proceeds – calculated using overall return on assets ratio

▪ Real return of covered bond issuance

After issuance bank gets funding from investor which can be used in another

investment instrument

▪ Yield requested by investor for a covered bond in Turkey including swap costs

Key assumptionsMethodology

▪ Size: Around Şekerbank issuance size –scalable enough to dilute issuance costs

▪ Maturity: 5 years

▪ Pool interest rate: sensitivity to different rates

▪ Rating: At least A3 rating by Moody’s –More than Şekerbank covered bond issuance

▪ All option and swap costs are market costs of December 2011

Key assumptions

Explanations

▪ We heard from banks that mortgage product is not profitabile, but rather used as a customer acquisition/retention product which enables cross-selling

▪ We should include possible additional income to be realized over the mortgage customer through the fund provided by issuance

▪ As a proxy, we used the return on assets of banking sector to estimate the additional return from mortgage customer

78|

Breakdown of covered bond economics – local investor base

Bps, December 2011

101001,300

Netrevenue

1,050 – 1,100

Issuance costs

30-40

Servicing costs

40-60

Required reserve cost

8-10

Option forrefinancing

40-60

Cost ofrisk

Cost of capital

Revenue from covered pool

0.5% NPL1 and 20% LGDratios are assumed to calculate credit risk

Interest swap takes place to convert fixed yield to floating

1 Non-performing loan ration in mortgage loans2 Risk weight of a mortgage loan is 50%, the capital adequacy ratio limit is 12% and ROE of banks is calculated to be ~15%3 Income before tax of banking sector in October 2011 is extrapolated and divided by June 2011 banking balance sheet (average of the year)

Covered bond poses a comparable financing source with a possibleadditional yield for the bank depending on market situation

Return from covered bond

0-100

Investor yield

TRLIBOR +20-70 bps

Swapped net revenue

TRLIBOR + 70-120 bps

Cost of capital is the opportunity cost of putting aside the capital banks need to hold to give the loan2

Investor expectation of Gov + 50-100 bps corresponds to TRLIBOR + 20-70 bps

Consists of both upfront and running costs

2

MBS should give 50-100 bps above t-bill to be appealing

Pension fund

Proceed return

Return from proceeds3

200-220

+

1

Estimation for average return coming from proceeds of issuance –calculated as income/total assets

SOURCE: Banks, Bloomberg

79|

1 All costs falling on banks side

Expected return from covered bond issuance changes with different mortgage yields and investor expectations

1

Covered bond economics

Mortgage return of the cover pool – differs from bank to bank

Investor spread on top of t-bill

Sensitivity analysis

1,300

Profitability of issuance

200-300


200-220


0-100

Investor yield

1,000-1,050

Bank costs1

~250

Mortgage revenue

Profitability without any return from proceeds

25015050-50-150150

27517575-25-125125

3002001000-100100

32522512525-7575

35025015050-5050Bps

37527517575-2525Investor spread

14%13%12%11%10%200with proceeds

Percentof issuance

Mortgage returnProfitability

25015050-50-150150

27517575-25-125125

3002001000-100100

32522512525-7575

35025015050-5050Bps

37527517575-2525Investor spread

14%13%12%11%10%200with proceeds

Percentof issuance


40-60-160-260-360150

65-35-135-235-335125

90-10-110-210-310100

11515-85-185-28575

14040-60-160-26050Bps

16565-35-135-23525Investor spread

14%13%12%11%10%-10without proceeds

Percentof issuance


40-60-160-260-360150

65-35-135-235-335125

90-10-110-210-310100

11515-85-185-28575

14040-60-160-26050Bps

16565-35-135-23525Investor spread

14%13%12%11%10%-10without proceeds

Percentof issuance


Issuance profitability including return from proceeds

Issuance profitability without proceed returns

Sensitivity analysis conducted to understand how profitability changes with changing mortgage return and spread

Negative return Positive return Base case

SOURCE: Banks

80|

Liquidity constraints can boost mortgage prices – evidence from selected EU countries

Spain mortgage loan rates Italy mortgage loan rates

2.70

2.75

2.80

2.85

2.90

2.95

3.00

3.05

3.10

3.15

3.20

3.25

10/117/114/111/1110/107/104/101/10

Percent Percent

3.45

3.50

3.55

3.60

3.65

3.70

3.75

10/117/114/111/1110/107/104/101/10

Mortgage loan rate increase during the peak of crisis

Mortgage loan rate increase during the peak of crisis

SOURCE: Bloomberg, Bank of Italy

1

81|

Under certain market conditions, covered bond is a better financing source for mortgages as its proceeds can be utilized for further loans

Funding sources

Covered bond issuance

Traditional funding

1,300

Return from traditional funding

100-200

Other costs1

~100

Cost of capital

~100

Cost of funding

900-1,000

Mortgage revenue

1,300

Return from covered bond funding

200-300


200-220


0-100

All-in-costs

1,200-1,300

Mortgage revenue

Funding cost comparison

1106010-40-90200

1601106010-40150

2101601106010100

2602101601106050Bps

3102602101601100(above t-bill)

11,0%10,5%10,0%9,5%9,0%10Investor spread

Percentdifference

Average funding costReturn

▪ In our sensitivity analysis, we are trying to identify when covered bonds become more profitable than traditional funding (e.g., time deposits, interbank lending etc.)

▪ For the analysis we chose 2 variables:– Average funding cost– Investor spread expectation (on top of government yield)

▪ In the table, numbers represent the difference between traditional funding and covered bond funding:

Traditional funding is more profitable

Covered bond issuance is more profitable

Sensitivity analysis

The difference between returns is independent from mortgage revenue

1 Includes option, servicing and reserve costs and cost of risk

Base case

SOURCE: Banks, Bloomberg, TBB

1

82|

Interest rate swap from fixed to floating rate is required to ensure that bank satisfies investor requirements

Rationale

▪ Mortgage loans in Turkey are generally fixed rate

▪ Investors request a floating return from their covered bonds: Government bond yield + 50-100 bps

▪ Banks need to hedge this interest rate riskas these bonds have long maturities

TRLIBOR + 160 bps

10.5%

11.5%

TRLIBOR + 110 bps11.0%

10.0%

9.9%

TRLIBOR + 10 bps

TRLIBOR + 60 bps

TRLIBOR

Floating yield in exchange with different fixed cash flows in IRS market

Interest rate swap from fixed to floating rate

Fixed return from cover pool

~10,6%

▪ Banks give fixed interest and swap partner provides a floating interest▪ Expected investor yield can be swapped into TRLIBOR + 20-70 bps in the

current IRS market

Floating return from cover pool

TRLIBOR +70-120 bps

Investor expectations

Gov + 50-100 bps

Floating investor expectations

TRLIBOR +20-70 bps

Cover pool yield Investor yield

SOURCE: Bank treasuries, interviews

2

83|

Contents





84|

A set of structured stakeholder interviews are conducted to develop capital market solution

Related main stakeholders

▪ Visits to market players and regulators

▪ We targeted following topics in each visit:

– Understanding the infrastructure (past) for project solution

▫ Need for secondary mortgage market

▫ Best international practices

▫ Investor appetite (will)

▫ Current legislative framework

▫ Market challenges/hurdles

– Design of proposed capital market solutions

– Possible roles of government, regulators and banks

CMB

Market players

BRSA

Treasury

85|

Banks indicate that they are aware of the need but they don’t have bias for leadership

Issuers and investors – Main constituent players of market

CMB

BRSA

Treasury

Private and public enterprises visited

Key messages

What they told us?Implications on Capital market solution design


▪ Mortgage market is small, so currently banks can fund through shorter term financing

▪ Going forward maturity mismatch will pressurize banks

▪ Sustainable local investor demand

▪ Investment limit

▪ Restrictions for portfolio allocation to securities other than government bonds

▪ None – Key requirements are more flexible compared to other EU countries

▪ Competition ▪ Competitor banks would not buy single originator bonds, multi-originators preferred

▪ Central solution

▪ Capital benefit

▪ Higher capital adequacy requirements

▪ Requirements are in line with European regulations

▪ Cash flow management

▪ Not repo-eligible in contrary to international benchmarks

▪ Need for government/regulatory involvement

▪ Regulatory hurdles

▪ Delays (1 month or so) occur due to regulatory hurdles

▪ CMB is not the bottleneck


▪ Investor expectation for the pricing of normalized Italian and Spanish MBSs over 100 bps

▪ Still profitable for funding banks

▪ Currency risk

▪ Currency is still a concern▪ Real money investors would be

interested only if in Euro or USD denominated

▪ Additional yield to investors to cover currency swap

▪ Customer relationship

▪ Mortgage loan is an anchor product, critical for customer retention

▪ Service provider role

Market players

SOURCE: Interviews

86|

CMB showed great interest in kick-start of secondary mortgage market and indicated to lead this entrepreneurship

Key messages

▪ CMB is planning to update regulations on covered bond, RMBS and other asset-backed securities. These updates will be useful for all participants of secondary mortgage market

▪ CMB is planning to design these updates according to secondary mortgage market practice outcomes

▪ CMB is proposing to broaden beneficiary spectrum by including Housing Development Administration (TOKİ) and other possible construction companies

▪ CMB also accepted the importance of a systematic solution and focused on market liquidity

▪ Furthermore, CMB indicated to lead the kick-start of secondary mortgage market

CMB has critical importance in terms of legislative framework

Marketplayers

BRSA

Treasury

CMB

SOURCE: Interviews

87|

Treasury is supporting central solution idea but will be an abstainer until some prerequisites are fulfilled

Key messages

▪ Undersecretariat of Treasury is also supporting systematic solution because of organized and standardized approach

▪ But in current situation, some fundamental obstacles/hurdles must be overcome before taking its support, such as: – Assessing public obligations of the process

regarding mortgage loan levels keeping up with current public debt as a result of mortgage increase due to GDP penetration

– Risk of secondary mortgage market tools competing with government issuances in case of treasury guarantee

– Current legislative framework of treasury not covering reassurance of private enterprise issuances

▪ Treasury will be more motivated to support only after some prerequisites are fulfilled, e.g., listing participant banks, establishing CIE administration, clarifying risk management procedures, etc.

Treasury for government support

Marketplayers

BRSA

CMB

Treasury

SOURCE: Interviews

88|

BRSA is supporting central solution idea due to its utilization for developing/improving banking sector balance sheet

Key messages

▪ BRSA is supporting the idea of alternative funding sources to fulfill future capital needs

▪ Furthermore, supporting funding solutions at RMBS level (securitization) which are important in terms of banking sector balances

▪ In midyear, when Basel II will be implemented as planned, application of an exceptional capital efficiency ratio to related funding tools in order to settle the disputes with Basel overseers may lead to problems due to increasing procedures. This is the main reason they refused to support this idea

BRSA is planning to provide financing space to banks

Marketplayers

BRSA

Treasury

CMB

SOURCE: Interviews

89|

Contents





90|

Defining and finalizing regulatory requirements

Required implementation plan for kick-starting secondary market for mortgage loans

▪ Defining legal structure▪ Developing organization

structure (including management company)

▪ Developing corporate management strategy

▪ Identifying capital requirements

▪ Developing methods for pricing structure and cost allocation between stakeholders

Finalizing (CIE) structure

▪ Improving critical processes (developing, restructuring, allocation,monitoring)

▪ Designing risk management policies and procedures

▪ Developing organizational scheme (including roles and responsibilities)

▪ Developingperformance management systems (including incentive methods)

▪ Developing IT systems ▪ Preparing rating

package

Designing fundamental factors of daily CIE operations

▪ Defining 5 year targets for program (also based on application of “eligibility criteria” to stakeholders’ credit portfolios)

▪ Economic/financial definition of program

▪ Assessing stakeholder oriented main benefits/impacts

▪ Market research with potential investors

Defining program strategy

▪ Defining possible improvements required for assignment criteria of participant banks via “Gap analysis”

▪ Identifying and tacking possible “external” factors (if available) e.g.,: Repo program, regulations specific to this topic, etc.

▪ Specifying program bond issuance details (establishing the mechanism,serial properties, size)

▪ Specifying details of bank’s covered bond cover pool (eligibility criteria, cover pool limits, over collateralization etc.)

▪ Defining program bond criteria (type of interest rate, payment scheme)

▪ Specifying payment flow type

▪ Designing liquidity method (mechanism, limits)

▪ Developing monitoring process and improving service reports

Detailing the program

▪ Registration of CIE due course of laws/legislations of regulatory bodies

▪ Developing detailed reporting and monitoring requirements for CIEactivities

▪ Defining roles and responsibilities of program bond investors and their representatives

▪ Approval of program by regulatory bodies

▪ Establishing CIE▪ Initial issuance▪ Selecting related parties

and assigning as representatives

▪ Rating▪ First transactional

investment

Launching

1. stage:Preparing the “Program”

2. stage:Launching

Expectations from banks in establishment of secondary mortgage market:

▪ Related support for the process and leadership

▪ Providing required capital for secondary mortgage market

▪ Allocating required resources/building work force for the transition