The regulatory experience of Colombia after the mortgage crisis Mauricio Cárdenas Director, Fundación para la Educación Superior y el Desarrollo (Fedesarrollo), Colombia Housing Finance Systems in Emerging Economies Session 6 Regulations and Education World Bank Group Conference, March 15-17, 2006

Outline 1.The Colombian housing finance crisis 2.Immediate response: Law 546 of Increase in minimum capital requirements: Laws 510/1999 and 795/ Upgrading risk management standards 5.Foreclosures 6.Results and challenges

Outline 1.The Colombian housing finance crisis 2.Immediate response: Law 546 of Increase in minimum capital requirements: Laws 510/1999 and 795/ Upgrading risk management standards 5.Foreclosures 6.Results and challenges

UPAC (indexation unit) and CPI Cumulative growth rates Source: Banco de la República and DANE.

UPAC (indexation unit) / Housing prices - Annual change - Average (Weighted) IPV for Bogotá. Source: DNP and Banco de la República

Source: ICAV. Calculations made by Fedesarrollo. Real interest rate on mortgages

MORTGAGE CRISIS Source: Superintendencia Bancaria. NPLs / Total outstanding mortgages

Foreclosures as % of total bank assets Source: Superfinanciera, November annual data

Total capitalizations made by Fogafín ( ) Millons of pesos and % Source: Fogafin TOTAL% of total Total non- mortgage public financial sector 3,509, Total mortgage2,547, Public financial sector 1,740, Private financial sector 806, Total non-mortgage private financial sector 956, TOTAL9,561,948100

Outline 1.The Colombian housing finance crisis 2.Immediate response: Law 546 of Increase in minimum capital requirements: Laws 510/1999 and 795/ Upgrading risk management standards Credit risk Market risk 5.Foreclosures 6.Results and challenges

Law 546 of 1999 Change in the system of indexation Transformation of S&Ls into banks Cap on real interest rates on mortgages Securitization New arrangements to deal with mismatches

Conversion of S&Ls into banks

Real interest rates on mortgage loans (points over UVR)

Securitization

True Sale of mortgage loans. Mortgage loans legally separated and isolated from the equity of the issuer and the originators. No legal possibility for issuers or mortgage originators´ creditors to claim rights on the mortgage loans even in case of bankruptcy or liquidation. Complete bankruptcy remote instrument. Independent accounting information. No intermediaries between the underlying assets and the bondholders Bondholders´ rights and obligations are determined exclusively by the rules of issuance. Universalidad: SPV created by Law 546

Credit Enhancements (Law 546 of 1999) Government guarantee on MBS –Revolving facility –Complete principal and interest guarantee –Restricted to MBS backed exclusively by social housing loans –Premium paid by the SPV

Outline 1.The Colombian housing finance crisis 2.Immediate response: Law 546 of Increase in minimum capital requirements: Laws 510/1999 and 795/ Upgrading risk management standards 5.Foreclosures 6.Results and challenges

Minimum Capital Requirements

Outline 1.The Colombian housing finance crisis 2.Immediate response: Law 546 of Increase in minimum capital requirements: Laws 510/1999 and 795/ Upgrading risk management standards Credit risk Market risk 5.Foreclosures 6.Results and challenges

Upgrading risk management standards Prior to the crisis, financial institutions had weaknesses managing and administrating risk. Under the new framework financial institutions should do their own risk evaluation. Self-determination of provisions and equity. Implementation of a new system (SARC) to evaluate and administer credit risk. Determination of the value of the exposure to market risk (interest rate, exchange rate, inflation, etc.). This value should be considered for complying with the solvency ratio (i.e. value at risk consumes capital)

Credit risk, SARC, and individual provisions Credit risk emerges from the possibility of losses from delinquent loans. The regulation established that financial institutions should develop internal models (SARC) to classify, evaluate, and cope with credit risk. In the future, provisions should be based on these models, which should also be used for credit analysis This is in a transitional phase. The models are ready for commercial loans. In the case of housing loans the system is still in its development stage.

Provisions According to the regulation, provisions should be made according to: 1.Internal models approved by the Superfinanciera. 2.Benchmark model developed by Superfinanciera (available only for commercial loans, pending for the rest). 3.Alternatively, provisions can be made according to the regulations set by Superfinanciera.

Current Individual Provisions Loan classification by destination: commercial, consumption, housing and microcredit Categories: A, B, C, D y E, depending on the quality or the delinquency time. –Class A normal risk –Class B tolerable risk but above normal –Class C considerable risk –Class D significant risk –Class E nonperformance risk

Housing Portfolio Provisioning Regulation (C.E. 052 of 2004 y C.E. 006 of 2006) category# of delinquency months Provision percentage over guaranteed portion Provision percentage over non-guaranteed portion A1% BBetween 2 and 53.2%100% CBetween 5 and 1210%100% DBetween 12 and 1820%100% EMore than 1830% (60% for two additional years) (100% for any additional year 100%

Provisions The regulators required in 1999 credit institutions to keep a general provision of 1% of their gross portfolio. In 2004 regulators exempted entities with adequate SARC models from constituting the general provision.

Source: Superfinanciera. BECH: Provisions/NPL

More progress.. Precise definition of housing loans Update of the guarantee value. For new loans internal valuation methodologies approved by the SF. If the entity does not its own internal methodology, the value of the guarantee will be adjusted using the housing price index (IPV) calculated by the DNP. The Superfinanciera and the Central Bank (BR) are working on bringing up to date the indicators that value guarantees.

Market Risk Solvency ratio (technical equity / assets weighted by risk) equal to 9% Financial institutions should measure the value of the portfolio exposed to market risks. They can use their own methodologies or the benchmark model developed by the Superfinanciera Greater risk exposure requires more capital.

Source: Superfinanciera. Solvency ratio (includes market risk)

Outline 1.The Colombian housing finance crisis 2.Immediate response: Law 546 of Increase in minimum capital requirements: Laws 510/1999 and 795/ Upgrading risk management standards 5.Foreclosures 6.Results and challenges

BeforeAfter Due notification to the defendant, through the Notifications Office (323 days) Notification through certificate mail send by the Bank (116 days) The sentence could be appeal if the defendant was represented by a public attorney (273 days) The appeal of the sentence was eliminated (63 days) Assets appraisal carry out by experts appointed by the court (111 days) Bank presents assets appraisal (commercial value or value set by the local tax authorities) (46 days) Foreclosure carry out solely at court rooms (143 days) Foreclosure carry out by commissioner (most used, auction in Chamber of Commerce and courts (second most used) (113 days) Foreclosure Proceedings: Law 794 of 2003

Lawsuit (8 days) Notice to the borrower Preparation of documents Sequestration (160 days) Asset appraisal (111 days) Debt liquidation (Including legal fees) (46 days) Judgment (273 days) Property assignment (58 days) Property delivery (138 days) Judicial Payment Order (46 days) Garnishment (41 days) Judicial foreclosure sale (143 days) Total time period of judicial foreclosure (1.187 Working days) JUDICIAL FORECLOSURE PROCESS BEFORE C.P.C. REFORM Rejection Admitted Not admitted amended Not Amended Lawsuit response No lawsuit response Borrower's Pleadings - Information to the bank Settlement meeting Presentation of evidence Closing arguments 323 days

Lawsuit (8 days) Notice to the borrower Preparation of documents Sequestration (160 days) Asset Appraisal (46 days) Debt liquidation (including legal fees) (46 days) Judgment (63 days) Property assignment (58 days) Property delivery (138 days) Judicial Payment Order (46 days) Garnishment (41 days) Judicial foreclosure sale (113 days) Total time period of judicial foreclosure (675 working days) JUDICIAL FORECLOSURE PROCESS AFTER C.P.C. REFORM. Rejection Admitted Not admitted Amended Not Amended Lawsuit response No lawsuit response Borrower's Pleadings - Information to the bank Presentation of evidence Closing arguments 323 days

Outline 1.The Colombian housing finance crisis 2.Immediate response: Law 546 of Increase in minimum capital requirements: Laws 510/1999 and 795/ Upgrading risk management standards 5.Foreclosures 6.Results and challenges

ROE (%) Source: Calculations Fedesarrollo *Commercial Banks do not include public banks *

Source: ICAV, Banco de la República. Calculations made by Fedesarrollo. Origination of mortgages

Source: ICAV, DANE. Calculations made by Fedesarrollo. Disbursements per squared meter licensed

Mortgage Portfolio as % of GDP in Colombia 1976 – 2004 (FALTARÍA ACTUALIZAR) Source: Clavijo, Janna, Múñoz (2005). Revista Desarrollo y Sociedad, First Semester.

Relative size of the mortgage industry Source: Superintendencia Bancaria. Housing loan porfolio/total loan portfolio Mortgage loan porfolio/GDP

Challenges ahead Prudential regulations has moved forward, but more progress is needed in other areas. Legal stability is key. Mixed results in the mortgage industry: –Greater competition, lower interest rates –Large number of financial mergers –Active development of a peso denominated fixed-rate primary mortgage market –Slow recovery of the mortgage origination –More progress is needed in the social housing sector

Appendixes: additional information Not to be presented

Securitization - Regulatory Framework 1.Law 546 of 1999 (Housing Law-TIPS Tax Exemption) 2.Law 633 of 2000 ( Tax Reform – Stamp tax - Other Exemptions (GMF) 3.Decree 1719 of 2001 – Ministry of Finance (Securitization companies exclusive corporate purpose) 4. Decree 2782 of 2001(Fogafin Guarantee)- Decree 576 of 2004 (guarantee term extension) 5.Decree 304 of Ministry of Finance (Resecuritization-TIPS Tax Exemption) 6.Resolution 117 of 2001 – Superintendency of Securities (Minimum capital requirements for securitization companies) 7. Resolution 775 of 2001 and 223 of 2002– Superintendency of Securities (MBS Rules- Universalidad-Applicable rules for Titularizadora) 8.Resolution 275 of 2001 – Superintendency of Securities (Corporate Governance) 9.Resolution 690 of August 12, 2004 (Capital Adequacy)

Provisions: recent changes Circular 20, 2005 –Establishes the Benchmark Model for Commercial Loan Portfolio, and the provision tables determined by the delinquency time are changed for statistical provisions based on countercyclical criteria. –Banks are allowed to present Internal Models for their Commercial Loan Portfolio. Circular 4, 2006 –Establishes a change in the provision tables by delinquency time –Establishes individual provisions for class A and B loan portfolio The Superfinanciera is planning on having Benchmark Models for consumption and housing loans during the year 2006.

Provisions Circular 88 de 2000 Determines the minimum qualitative requirements for the management of market risk in trading Circular 42 del 2001 Establishes Benchmark Models and allows the use of Internal Models for the calculation of VaR, given the previous authorization of the Superbancaria. Circular 31 del 2004 U pdates the Benchmark Models. Establece un consumo de capital regulatorio mínimo por riesgo de mercado para las Entidades Vigiladas.

Provisions: main standards and regulations External Notification 039 of 1999 (partially modified by the notifications 044 and 046 of the same year) External Notification 011 of 2002 External Notification 052 of 2004 (partially modifies by E.N 004 of 2006)