Foreign currency debt – The slide of the Turkish Lira

Lenders with foreign hard currency loans like US Dollar and Euro to Turkish borrowers (both financial institutions and corporates) need to pay close attention to the economic and political situation in Turkey. Some lenders have been approached by borrowers to refinance existing loans and we expect that this trend will continue.

The slide of the Turkish Lira, the fact that most foreign currency debt is not hedged and a wall of repayments coming up are factors for real concern.

Turkish lenders are also expected to undertake more debt sales in the coming days/weeks. According to the Banking Regulatory and Supervision Agency data, the amount of non-performing loan (NPL) stock has reached TL 74 billion (approximately US$14 billion) as of June 2018. Wholesale trade and commission-based sales generate the largest amount of NPL (4.23 per cent) with the construction sector generating 2.85 per cent NPL and the energy sector (generation and distribution) generating 2.32 per cent NPL.

Lenders are advised to review their Turkish debt portfolios to address possible restructuring/amendment requests. Another consequence of the current situation is that we may see more private equity funds and corporates buying up debt and making acquisitions in Turkey.

Contingency planning

If you are a lender/agent or mandated lead arranger (MLA) and you consider that one of your Turkish borrowers (also look at your guarantor structure) is facing a liquidity crisis to meet scheduled repayment installments you should be

• Speaking to expert legal counsel (see our contact details at the end of this summary).
• Making sure you have access to all finance documents for review.
• Understand the immediate liquidity requirements of your borrower group and understand the supplier credit situation and what credit insurance (you will need an update of credit limits) is in place, if any. Understand hedging arrangements, if any.
• Ensure the financial reporting is being delivered on time and consider requesting increased financial data.
• Understand voting requirements in your finance documents; understand which lenders have blocking rights and the consent level for amendments and waivers.
• Consider selling your debt / understand what level the debt is trading at.
• Ascertain if there have been any defaults and consider sending a reservation of rights letter.
• Consider a bank meeting: start warming yourself up to what needs to be done to form a creditors committee (no authority or with authority) - think about a standstill.
• Understand what amendments need to be made to the facility e.g. amend repayment schedule (which could involve an accelerated clean down), relax covenants, increase reporting and shorten timeframes for delivery (you will need budgets and cash flow forecasts), limit use of any revolver, limit any further drawings if commitments are available (draw stop), tighten/loosen baskets and dividend blocks.

Turkey’s foreign currency lending regime has been recently amended with an effective date of May 2, 2018 as a risk management step to reduce the domestic foreign exchange exposure of Turkish legal entities and individuals. The new regime introduced significant restrictions to obtaining foreign-currency denominated loans (FX Loans) and foreign-currency-indexed loans (FX-Indexed Loans) by Turkish legal entities and individuals.

The Council of Ministers Decree No. 2018/11185 (the Amendment Decree), which modified the Decree numbered 32 on the Protection of Value of the Turkish Currency, terminates the ability of Turkish borrowers to obtain FX-Indexed Loans, and restricts the availability of FX Loans extended by both domestic and international lenders.

The Amendment Decree removes the ability of Turkish individuals to obtain both FX Loans and FX-Indexed Loans. As to legal entities, the Amendment Decree prohibits the FX-Indexed Loans, and limits, as a general rule, the extension of FX Loans to those legal entities with foreign currency income only. Legal entities with no foreign currency income are able to borrow in foreign currency only if they or the borrowing concerned fall within one of the exceptions specified therein.

On May 2, 2018, the Central Bank published further details on the new regime in a new capital movements circular (the Capital Movements Circular) which revokes the earlier Capital Movements Circular of January 2, 2002.

Under the new regime, save for certain exceptions, foreign currency income is a prerequisite to obtain foreign currency loans.Legal entities with foreign currency income are allowed to obtain FX Loans up to an amount equal to their aggregate foreign exchange income within the last three financial years.

“Foreign currency income” means any income generated from export, transit trade and trade and deliveries deemed as export and foreign currency generating services and transactions.

Verification of the aggregate foreign currency income is the responsibility of the lender for domestic lenders, or the intermediary Turkish bank for international lenders. Should a borrower’s foreign currency income verification prove to be incorrect, the portion of the disbursed FX Loan in excess of the total foreign income over the last three fiscal years will need to be recalled or converted to a Turkish Lira loan.

Legal entities which cannot generate foreign currency income are not allowed to obtain FX Loans, unless an exemption applies. For instance, public institutions or certain financial institutions do not have to fulfill the foreign currency income requirement. In addition, if a borrower has an outstanding minimum foreign currency loan balance of US$15 million (or its equivalent in another foreign currency) or the borrowing is to finance a PPP or privatization project then the foreign income test does not apply.

Entry into force of the Amendment Decree does not affect the validity of the FX Loans which have been already disbursed. Nevertheless, as of May 2, 2018, such loan facilities shall not be renewed as FX-Loans, unless the borrower is entitled to obtain such loans under one (or more) of the exceptions.

The new rules have also introduced new reporting and monitoring requirements for banks. For instance, they must notify the Risk Center the Banks Association of Turkey of foreign currency loans extended to Turkish residents. Similarly, they must monitor the repayments of foreign currency loans and notify the Risk Center of the repaid amounts by deducting the same from the borrower’s foreign currency credit balance.

There are also reporting requirements imposed on borrowers. The Central Bank issued a regulation requiring borrowers to notify their foreign currency loan balance through an electronic portal. Content of the notifications need to be confirmed by an independent auditor as well.

It is of utmost importance for Turkish companies and their lenders to closely monitor the company's financials. Indeed, the Turkish Commercial Code requires the board of directors to take immediate action if certain part of the paid-in capital and statutory reserves is lost or the company's financial situation has deteriorated. For instance, they may be required to prepare a remedial plan which will then be submitted to the general assembly of shareholders for approval and which could include measures including increase of the share capital.

If the remedial plans and measures do not work and the Turkish company fails to pay its debts as they become due or its assets are not enough to cover its debts, it may be declared bankrupt upon application by the company itself or its creditors. As a result, the company may be subject to bankruptcy proceedings which, if the situation is not remedied, may lead to liquidation of the company. Insolvent companies may seek formal measures similar to Chapter 11 proceedings, whereas distressed companies may seek out-of-court work-outs to avoid bankruptcy.

Turkish bankruptcy laws do not include provisions on "informal" corporate work-outs. However, such work-outs would still be enforceable under Turkish contracts law by the creditors who are parties to them. Informal work-outs must not be used to defraud non-party creditors by hiding assets from them.

Applicable Turkish rules provide for two main types of scheme of arrangement: (i) composition with creditors (konkordato) and (ii) amicable restructuring (uzlaşma yoluyla yeniden yapılandırma). The major differences between the two is that composition applies to all creditors whereas the amicable restructuring can be executed with a group of creditors. In addition, while the composition targets the restructuring of the debt obligations (changing the maturity date, reducing the amount of the debt etc.) the amicable restructuring aims at transforming the business and operations. It may therefore include remedies such as asset transfer, merger with another company or change of management, in addition to the restructuring of the debt. In that sense, the amicable restructuring is more similar to a Chapter 11 procedure under the US law.

Composition with creditors. Insolvent debtors or their eligible creditors (secured or unsecured) may request a composition with creditors from the Turkish commercial courts. After the abolishment of postponement of bankruptcy procedure, it is expected that the composition with creditors will be used more frequently.

The aim of requesting a composition with creditors is to reach an agreement to determine new maturity dates for the debt and/or reduce the amount of debt based on a remedial plan.

If the court decides that the remedial plan is viable, then it grants a period of one year during which the composition process needs to be completed. This one-year composition period may be extended up to only six months in exceptional cases. During this period, the creditors cannot initiate new legal proceedings against the debtor. Additionally, it is not possible to get preliminary injunctions or initiate attachment proceedings against the debtor.

Furthermore, during the composition period, no interest would accrue on unsecured claims. Secured creditors are entitled to initiate or continue with the foreclosure of their pledges; however, no protective measures can be taken or the pledged assets cannot be sold during the composition period.

Amicable restructuring. This scheme of arrangement applies only to corporates (limited companies, joint stock companies or co-operatives save for banks or insurance companies). The amicable restructuring may be initiated by companies which are not able to or may not be reasonably expected to pay their debts. Unlike the composition with creditors explained above, initiating an amicable restructuring is within the discretion of the debtor, who starts negotiations with its creditors to discuss a restructuring project. It is also within the debtor's discretion to decide which debts will be part of the restructuring project and which creditors will be affected by it (i.e. will be part of the restructuring).

If the restructuring project is accepted by the requisite majority of the creditors (being affected by the project), the company applies to the court for its approval. The court hears the debtor company's representatives, creditors present at the hearing, and the auditor (if available). The court should approve a viable project, prepared and submitted in good faith and which complies with the applicable rules. Creditors who have objected to the project are also bound by its terms. However, the amount they are entitled to under the project should be equal to or exceed the amount which they would have received in case of the liquidation of the company upon bankruptcy.

The court may take appropriate measures to protect the debtor's assets during the term of the project, including suspension of legal proceedings initiated against the debtor by affected creditors or prohibiting the affected creditors from getting preliminary injunctions or initiating attachment proceedings against the debtor. However, unlike the composition with creditors the suspension of execution proceedings is not automatic or by virtue of law, but is within the discretion of the relevant court.

Our Istanbul office

Our Istanbul office draws on the firm’s established Turkey practice to counsel clients in mergers and acquisitions, private equity, privatization, capital markets, corporate finance, project finance and securities. The Istanbul team has significant experience in a variety of sectors, including banking, financial services, telecommunications, energy, real estate, consumer goods, natural resources and construction. Our Istanbul-based professionals are all natives of Turkey and are fluent in Turkish and English. Through our professional affiliation with İnal Kama Attorney Partnership, we provide clients with Turkish legal advice.