Turkey: TIER II Loans And Its Ranking Under Turkish Law

The Basel Committee on Banking Supervision proposed reforms after 2007, known as Basel III. The Basel Committee, including Turkey, decided to implement Basel III starting from 2013 until 2019. The regulation on equity of banks (the "Regulation") is one of the regulations introduced by Basel III, which the Banking Regulation and Supervision Authority of the Republic of Turkey (the "BRSA") is prepared to implement1. The Regulation was enforced on January 1, 2014 and abolished the previous regulation on equity of banks dated November 1, 2006 (the "Previous Regulation").

A bank's total capital is calculated by adding total tier I capital (ana sermaye) that comprises of common equity tier I capital (çekirdek sermaye) and additional tier I capital (ilave ana sermaye) to tier II capital (katkı sermaye), minus the items to be deducted from the sum of total tier I capital to tier II capital.2

This article outlines the main features of subordinated loans that will qualify as tier II capital of a bank3 (the "Tier II Loan") and the ranking of Tier II Loans under the Regulation and Turkish law.

Features of Tier II Loans:

(i) Prepayment:

The repayment term of the Tier II Loan should be more than five years. The loan agreement regulating the Tier II Loan should not call for principal repayment during the first five years following its disbursement.

  • Voluntary Prepayment:

    A Tier II Loan may be voluntarily repaid before its due date, only after the fifth anniversary of the Tier II Loan's disbursement to the borrower, and subject to the BRSA's prior written approval. In order to consent a voluntary payment, the BRSA considers the following criteria:

    • The bank should not have led an expectation in the market that it will exercise its voluntary prepayment option (this criteria will not be applied to subordinated loans but it will be applied to the Tier II Bonds); and
    • liability arising from the Tier II Loan to be prepaid should be replaced with another liability that has the same or better qualities and such replacement should not limit the bank's operations; or
    • after the prepayment, the bank's capital adequacy ratio should be higher than the minimum amount determined by the banking regulations or by the BRSA.
    The rationale behind the aforementioned criteria is that the bank borrows a Tier II Loan in order to meet the capital adequacy ratio imposed by the BRSA, therefore, after the prepayment of the Tier II Loan (i) the bank should not have a capital adequacy ratio lower than the ratios determined by the banking regulations or by the BRSA, or (ii) if the bank cannot achieve item (i), the bank should replace the Tier II Loan with another liability in order to achieve the capital adequacy ratios.

    If Turkish tax legislation or other regulations are significantly amended in the meantime, the Tier II Loan, still subject to the prior approval of the BRSA, may be prepaid before its fifth anniversary.
  • Mandatory Prepayment:

    The Regulation states that the lender should not request repayment of the Tier II Loan prior to its scheduled repayment date. A Tier II Loan should not be repaid, even if the borrower is in default, before its original repayment date, which should be later than the fifth anniversary of the loan. A mandatory prepayment should also be subject to the BRSA's prior written approval.

(ii) Interest:

The Regulation, by specifying that the interest rate should be clearly determined in the loan agreement, does not allow application of floating interest rates to Tier II Loans. The interest rate should not be extremely higher than those of similar loans. The rates or dates of interest payments should not be changed according to the Bank's creditworthiness.

Additionally, the lender is not entitled to apply a step-up interest rate to promote early prepayment. However, under the Previous Regulation, the lender was entitled to apply step-up interest following the first five years of the Tier II Loan, provided that the increase in the interest is not higher than the lower of (a) 1%, and (b) 150% of the initial interest rate.

If a Tier II Loan agreement was executed before January 1, 2014, when the Previous Regulation was in effect, and includes a step up interest provision to be applied after January 1, 2015, such loan will not be considered in the calculation of bank's total capital, following the date when the step up interest is applied.

(iii) Security:

The lender of a Tier II Loan should be unsecured. A Tier II loan cannot be directly or indirectly securitised.

(iv) Subordination:

In case of the borrower's bankruptcy, as explained below in detail, the repayment of the Tier II Loan should be subordinated to claims of depositors, and all other debt of the bank except the ones owed to shareholders. The lender would be repaid only immediately prior to shareholders.

The loan agreement regulating the Tier II Loan, should not be linked to any other agreement that disqualifies the Tier II Loan's subordination criteria mentioned above.

(v) Assignment of the Tier II Loan:

The Tier II Loan should not be assigned to any other company controlled by the bank.

(vi) BRSA's Approval:

The BRSA should approve that the Tier II Loan is eligible to qualify as Tier II Capital of the Bank. The BRSA requests the following in order to make its assessment:

  1. A letter from the board of directors of the bank, certifying that the Tier II Loan fulfils the criteria set out in the Regulation to qualify as Tier II Capital; and.
  2. The loan agreement, in Turkish, as explained below:

    • If the agreement is signed prior to the date of application to BRSA for approval, the original or a notarised copy of the agreement should be submitted; or
    • If the agreement is not signed as of the date of application to BRSA for approval, the bank should submit a draft of the agreement. Within five business days following the BRSA's approval (i) the signed copy of the agreement or its copy certified by a notary public should be submitted, and (ii) a letter from the bank's board of directors certifying that the draft agreement submitted to the BRSA for its approval and the signed copy are identical, or the signed copy does not include any change effecting Tier II qualifications of the loan.

Following the BRSA's approval, a Tier II Loan will qualify as a Tier II Capital of a Bank. However, each year, following the last five years of the Tier II Loan, 20% of that Tier II Loan will no longer be taken into calculation in the determination of the bank's Tier II Capital.

Ranking of Tier II Loans under the Execution and Bankruptcy Law

As one of the main principles governing Tier II Loans, the creditor of a Tier II Loan shall be entitled to receive and retain any payment, in case of bankruptcy of the bank, only after fulfilment of all claims by the bank's depositors, secured creditors, unsecured creditors, and only ahead of any payments to be made to the bank's shareholders4. To demonstrate the ranking of Tier II Loan providers under Turkish law, considering the Execution and Bankruptcy Law and the Regulation, the proceeds to be obtained as a result of the sale of a bankrupt bank's assets will be distributed among its creditors in the following order:

  1. tax and duties arising from such sale;
  2. secured creditors (e.g. pledgee and mortgagee);
  3. employees' payments;
  4. receivables arising from family law;
  5. privileged creditors preferred by Turkish law including:

    • receivables of the Central Bank of the Republic of Turkey;
    • receivables of the Social Security Institution of the Republic of Turkey.
  6. other unsecured creditors;
  7. creditors of subordinated debts; and
  8. shareholders.

Some Principles of Tier II Loans that the Regulation does not capture:

The Regulation is silent on some overriding principles of Tier II Loans mentioned below, which were regulated under the Previous Regulation:

  • The Previous Regulation stated that a borrower of a Tier II Loan should not have an option to make multiple prepayments5. The Previous Regulation was clear that the principal repayment of the Tier II Loan shall be in one payment whereas; the Regulation is silent on the issue whether prepayment can be made in multiple instalments. However, the wording "prepayment plan" in article 8/3 (e) of the Regulation gives an impression that the Regulation allows multiple instalments for the principal amount of the Tier II Loan;
  • The Previous Regulation stated that, if the borrower has an option to prepay the Tier II Loan, the prepayment date should be clearly specified in the loan agreement. The Regulation does not regulate whether the prepayment date shall be specified in the loan agreement;
  • The Previous Regulation also ordered that the Tier II Loan must be disbursed in one lump sum6. The Regulation does not include any provision on whether partial disbursement of the Tier II Loan is allowed.

Finally, if a Tier II Loan qualifies as Tier II Capital in accordance with the Previous Regulation and does not fulfil the criteria stipulated under the Regulation, each year following January 1, 2015, 10% of such Tier II Loan will not be taken into consideration in the calculation of the Banks' total capital.

However, the total amount of a Tier II Loan (that qualifies as Tier II Capital in accordance with the Previous Regulation) will no longer be qualified as Tier II Capital following the date when the step up interest is applied.

Footnotes

1. The BRSA's announcement dated July 2013 and numbered 2013/20.

2. Articles 4 and 5 of the Regulation.

3. Article 8 of the Regulation.

4. Article 206 of the Code of Execution and Bankruptcy and article 8/2(b) of the Regulation.

5. Article 8/1 (b) of the Previous Regulation.

6. Article 8/1 (ç) of the Previous Regulation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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