The US$60 million Islamic financing for Derindere Turizm Otomotiv San Tic (Derindere), which concluded last November, was a landmark transaction for the Turkish Islamic financing market in many respects.
It is the first five-year syndicated Islamic financing for a Turkish company, the largest syndicated Islamic financing for a company from the Turkish commercial banking segment in Turkey to date, and the first international financing for Derindere. The financing was arranged by Citi.
A remarkable aspect was that it was significantly oversubscribed in syndication despite having a relatively long tenor of five years. Hulusi Horozoglu, vice-president of global Islamic banking for Citigroup Global Markets, said the syndication was oversubscribed by 75% and the final size of the financing facility had to be scaled back to US$60 million on a pro rata basis at the request of Derindere.
Citibank distributed the syndication to a diversified group of financial institutions in the Middle East, North Africa and Europe. All of these represented new investors for Derindere.
In addition to the Islamic financing, a Shariah compliant currency hedging transaction (a US dollar/euro cross-currency type swap) was also executed for the full facility amount. Derindere obtained synthetic euro financing in order to fund the purchase of vehicles, which is made mostly in euros. Citi was the Islamic hedging counterparty, and this is the largest Islamic hedging transaction executed in Turkey to date.
Citi Islamic Investment Bank was the documentation agent and its Shariah Advisory Board approved the financing structure (together with the related finance documents).
Financing structure and documentation
The Islamic financing for Derindere was structured as a commodity Murabahah. Principal documentation comprised a commodity Murabahah agreement and an investment agency agreement.
The commodity Murabahah agreement was entered into between Derindere and Citibank International, acting as the investment agent. Parties to the investment agency agreement were the financiers, the investment agent, the security agent (Citibank), the documentation agent and Derindere.
Under the commodity Murabahah agreement, the investment agent agreed to purchase certain Shariah compliant commodities at the request of Derindere from a commodities broker.
Immediately after purchasing the relevant commodities, the investment agent would sell them to Derindere at a mark-up and on deferred payment terms.
Derindere would then appoint the investment agent as its undisclosed agent solely for the purposes of on-selling the commodities on a spot basis and crediting the proceeds to a US dollar-denominated blocked account (see “Blocked accounts and LTV-style covenant” for more details on the use of blocked accounts).
The investment agent and Derindere could only enter into a single Murabahah trade for the purchase of commodities by Derindere under the terms of the commodity Murabahah agreement and the marked-up deferred price would be payable by Derindere in instalments over five years.
Under the investment agency agreement, the financiers agreed to fund the aggregate cost price of the commodities purchased by the investment agent at the request of Derindere. In return, each financier would be entitled to its share in the marked-up deferred price payable by Derindere under the commodity Murabahah agreement.
The investment agency agreement also set out the appointments of the investment agent and the security agent as well as the terms governing the relationship between the various finance parties.
Both the commodity Murabahah and investment agency agreements were governed by English law and Allen & Overy LLP acted as English counsel to the arranger and the other finance parties and Pekin & Pekin acted as Turkish counsel.
Blocked accounts and LTV-style covenant
One of the distinctive features of the Derindere Islamic financing was the use of a blocked accounts structure. Under the terms of the financing, Derindere was to open three blocked accounts with Citibank in Turkey, which were all pledged to the security agent under an accounts pledge governed by Turkish law.
Each blocked account was denominated in a different currency: one in US dollar, the second in euro and the third in new Turkish lira.
The proceeds of the commodities on-sold by the investment agent as Derindere’s undisclosed agent (the Murabahah proceeds) would be deposited into the US dollar denominated blocked account first.
These funds were earmarked for use by Derindere mainly for purchasing vehicles to add to its fleet of vehicles for sale or lease to Derindere’s customers.
Once the Murabahah proceeds were deposited into the US dollar denominated blocked account, Derindere would be free to move these funds into the euro and/or new Turkish lira denominated blocked accounts in order to fund the purchase of the relevant vehicles, subject to compliance with a loan-to-value (LTV)-style covenant.
Under the LTV-style covenant, the outstanding principal amount of the marked-up deferred price payable by Derindere could not exceed a certain specified percentage of the value of vehicles pledged by Derindere as security for its obligations under the finance documents.
For the purpose of determining compliance with the LTV-style covenant, the aggregate funds standing to the credit of the blocked accounts were deducted from the principal amount outstanding of the marked-up deferred price.
The valuation of the secured vehicles for the purposes of the LTV-style covenants would be based either on their purchase price (for new vehicles) or by reference to the relevant market values determined by the Association of the Insurance and Reinsurance Companies of Turkey (in the case of older vehicles).
The application of the LTV-style covenant was suspended for a certain period during the initial period of the facility. This was to enable Derindere to use the Murabahah proceeds to purchase the relevant vehicles and pledge them in favor of the security agent.
After making the initial vehicle purchases, the blocked accounts gave Derindere the flexibility to “drip feed” itself the funds to purchase new vehicles as and when it needed to update its fleet without having to enter into any further commodity Murabahah trades.
Derindere was free to choose when, and how much, it could withdraw from the blocked accounts, as long as it remained within the LTV-style covenant following the withdrawal.
From the perspective of the financiers, the blocked accounts structure simplified the administration of the facility as the parties only needed to enter into a single Murabahah trade.
It also meant that the profit element of the marked-up deferred price was determined in full following the first (and only) Murabahah trade.
The financiers could start receiving payments of the profit element even if Derindere chose to delay withdrawing monies from the blocked accounts to fund the purchase of vehicles.
The structure also expanded Derindere’s options to remedy any potential breach of the LTV-style covenant. In addition to granting security over additional vehicles or prepaying some of the marked-up deferred price instalments, Derindere had the further option of depositing funds into the blocked account.
For Derindere, this had two advantages:
(i) in contrast to a prepayment, a payment made into a blocked account could be withdrawn again for use in the future; and
(ii) in contrast to providing additional vehicle security, depositing additional funds into the blocked accounts is relatively straightforward and quick.
Security package and personal guarantee
In addition to vehicle pledges and the blocked accounts, the security package for the financing included an assignment of insurance proceeds in respect of the leased vehicles, an assignment of the vehicle leases and a pledge over a collection account. All of these were also governed by Turkish law.
Derindere was obliged to ensure that payments under the vehicle leases, any insurance proceeds and the proceeds of any vehicles sold were paid into a designated collection account with the security agent.
The payments into the collection account had to show a specified minimum monthly flow as proof of Derindere’s ability to make upcoming scheduled payments of the marked-up deferred sale price. Derindere’s payment obligations under the financing were guaranteed by one of its principal shareholders.
Conclusion
The Derindere Islamic financing demonstrated the growing appetite of Islamic banks and financial institutions to invest in jurisdictions outside the traditional Islamic finance hubs of the Arabian Gulf and Southeast Asia.
The transaction is likely to pave the way for future Islamic financings in the Turkish market, given the success of its syndication.
Derindere Turizm Otomotiv San Tic
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