Mahesh Kotecha, CFAMahesh Kotecha, CFA President, Structured Credit International Member of the Board of Directors, BRC Investor Services S.A Sociedad Calificadora de Valores Tel:

Mahesh Kotecha, CFA

President, Structured Credit International Member of the Board of Directors, BRC Investor Services S.A

Sociedad Calificadora de Valores

Tel: 212-605-0123 Fax: 212-605-0222

[email protected]

The Colombian Financial Sector From an Investor Perspective

1. Financial Crisis and its Aftermath 2. Strengths of the Financial Sector

3. Weaknesses of the Financial Sector

4. Future Opportunities

FINANCIAL CRISIS AND ITS AFTERMATH

5.5%9.23%Inflation

10.6%-10%Loan

17.29%0.32%Deposit

4.1%-4.2%GDP

13.6%18.1%Unemployment

25%-6.1% International Reserves

2004 1999 Indicators growth

Colombia Has Recovered and Grown Since the Crisis


Entities Liquidated or Merged (1998-2005)

113Compañías de financiamientocomercial

22419TOTAL

65Corporación Financieras

14Mortgage banks

267Commercial banks

NationalizedLiquidatedMerged


Mortgage and Publicly own Banks

•These were the most affected by the crisis

•Both groups have largely recovered

•Ratings for both groups have been raised.

•The publicly own banks received equity injection of $4.7 billion from the government

•The private banks received $2.1 billion, through their stockholders and Fogafín


Mortgage and Public Banks Have Been Upgraded

AA+ABank 4*

AAAAA+Bank 3*

AA+ABank 2

AA+AA -Bank 1

Present RatingBefore Crisis

* Before crisis correspond to 2002 and 2001 ratings, No information available before.

Source: Rating agencies in Colombia


Mortgage and Public Banks

Public BanksMortgage Banks

10.3

6.1%

30.07%

2.85%

2004

13.0

22.2%

-49.9%

-3.8%

1999

10.511.7Assets / Equity

3.9%25.8%Past due loans / Total loans

21.48%-129.9%ROE

2.26%11.1%ROA

20041999

1. Financial Crisis and its Aftermath

2. Strengths of the Financial Sector3. Weaknesses of the Financial Sector


STRENGTHS OF THE FINANCIAL SECTOR

Growth of the Financial Sector: 2000 – 2005

3.893.843.763.313.003.52Net interest income / Total assets (%)

26.0624.613.594.323.483.15Equity growth (%)

20.1721.167.955.319.002.46Deposit growth (%)

17.7520.586.855.3-0.46-8.6Loans growth (%)

18.5618.139.105.874.790.43Assets growth (%)

200520042003200220012000


CAMEL Framework Can Be Used to Assess the Financial Sector’s Performance

• BRC rates 23 financial institutions, including banks, CF, CFC and Leasing companies

• We use the CAMEL framework to discuss financial sector improvements


CAPITAL

-

20

40

60

80

100

120

140

0 20 40 60 80 100 120 140

2004

1999

56% of the institutions had improved their solvency index


ASSET QUALITY

13.6%

11.0%

9.7%8.7%

6.8%

3.3%

0%

2%

4%

6%

8%

10%

12%

14%

16%

1999 2000 2001 2002 2003 2004

Ass

ets

qu

alit

y

36.79

56.64

77.4986.53

98.49

145.46

0

20

40

60

80

100

120

140

160

1999 2000 2001 2002 2003 2004

Cov

erag

e

Assets quality = Past due loans / Total loans

Coverage = Provisions / Past due loans


MANAGEMENT

• Better corporate governance criterions

• Higher level of provisions

• Improvements in risk managements

• Better efficiency ratios


EARNINGS

Corresponds to the net income of the Colombian financialsector, in real terms. Pesos 2004

- 4 , 0 0 0 , 0 0 0

- 3 , 0 0 0 , 0 0 0

- 2 , 0 0 0 , 0 0 0

- 1 , 0 0 0 , 0 0 0

-

1 , 0 0 0 , 0 0 0

2 , 0 0 0 , 0 0 0

3 , 0 0 0 , 0 0 0

Mill

on

s o

f pes

os

(200

4)

1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4


Return on Equity and Assets: July 2005

8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0

Foreign banks

Corp Financ

CFC

Leasing

TOTAL

Mortgage

Banks

National banks

Public banks

ROE

z

0.0 0.5 1.0 1.5 2.0 2.5 3.0

Foreign banks

Leasing

Public banks

Mortgage

TOTAL

Banks

National banks

CFC

Corp Financ

ROA


LIQUIDITY AND FUNDING

30%

35%

40%

45%

50%

55%

60%

65%

1998 1999 2000 2001 2002 2003 2004

CDT Saving act0.8

0.9

1.0

1.1

1.2

1.3

Dep

/ lo

ans

1999 2000 2001 2002 2003 2004


Bank Supervision Has Improved

Capital requirements for market risk were introduced in December 2001

• As investment in government paper has risen sharply and as there is a limited number market makers, market risks are now more significant

A new loan classification system was introduced by the regulator

• SARC (Sistema de Administración de Riesgo Crediticio) creditrisk model based on Basle II principles

• If a bank does not develop its own IRB system it may use a model created by SBC as a starting point


2. Strengths of the Financial Sector



WEAKNESSES OF THE FINANCIAL SECTOR

But the Financial Sector Remains Weak

• The depth of the financial sector has declined, with the ratio of [(M3 – cash) /GDP] falling from 35% in the early 90’s to < 30%

• Market capitalization of the stock exchange as % of GDP is lower than elsewhere in Latin America (<20% versus over 40% in Brazil)

• Limited access to equity and debt markets (especially for banks rated AA or lower) constrains further strengthening of the financial sector

• With the large holdings of government paper by banks, they are now subject to higher market risks because of maturity mismatches.

• One percent change in interest rates would have resulted in decrease in 2004 level of earnings by 17.07 percent *

* Reporte de Estabilidad Financiera – Julio de 2005 – Banco de la República

WEAKNESSES OF THE FINANCIAL SECTOR

But the Financial Sector Remains Weak (cont)

• In some cases the financial intermediaries have jumped into marketsthat may have worked for others without fully determining whetherthey are really ready for them: e.g., Microcredits, VIS

• Lack of competition from international banks limits the pace of modernization of the financial sector and choice for the borrowers

• Frequent changes of tax regimes for corporation and individuals poses uncertainties

• With higher market risks, it is necessary to make more emphasis on market risk management


2. Strengths of the Financial Sector



FUTURE OPPORTUNITIES

Opportunity 1: Public Banks’ Privatization

ü Privatization offers revenues for the government,

üProfessional management for the banks

üMore competitive banking sector

OBut labor relations could pose challenges for the new owners

OFurther progress should be made in measuring, control and regulation of operational risk

O Need to clarify government vision about the structure of the banking sector

OThe government should make additional efforts to finish the privatization of the banks it has announced


Opportunity 2: Securitization is Growing

ü BRCIS has rated 25 securitizations

üOf these, just over a half -- 13 -- involve asset sales by banks

ü We believe there is room for greater use of securitization for risk management and other purposes by banks

üBut the growth of this market is limited by market understanding of structured finance, including legal, structural, seller / servicer and asset quality risks


Opportunity 3: Improving Risk Management

üWith heightened market risks, more market oriented lending and the advent of Basle II principles, there is need to strengthen the risk management practice of banks

üModel-based systems of risk management need to be considered and practical methods of risk assessment, risk mitigation and risk control need to be broadly implemented to avoid future financial crises

üRatings – both external and internal - provide means to improve risk management


Opportunity 4: Encourage international competition

üThe presence of international banks should be encouraged to increase the quality of competition

• Benefits could include increased quality and quantity of banking services for corporate and retail customers

üThe Colombian financial sector will be strengthened as it will need to make improvements in order to face the domestic and international competitors


Opportunity 5: Mergers and acquisitions

üBetween 1998 and 2000, the consolidation process was necessary to emerge from the crisis

üIn 2005 the consolidation offers opportunities to implement more effective strategies with the objectives of

ü Cost reductions and increased returns

ü Market position gains

ü Greater competitiveness

ü Improvements in size

APPENDIX:

Risk Management:

RISK MANAGEMENT

Role of Ratings and Credit Models

ü A credit rating is provided by an independent rating agency which has some market credibility, a rating scale and a wealth of issuer that it has rated

• Typically used for capital market investments

• Increasingly used by regulated financial institutions

üCredit models are generally quantitative methods for determiningthe likely that credit risks will arise in given market segments, typically (but not exclusively) corporate risks

• Traditionally used in consumer lending where the law of large numbers made their use attractive

• Many models now use ratings based default probabilities

• Other innovative quantitative methods based on discriminate analysis, option theory, etc.

RISK MANAGEMENT

Comparing Ratings and Credit Risk Models

Applied more for risk and portfolio management purposes

Used in capital markets for pricing and marketing securities

Overall assessment

Based on mathematical analysis and market data with tendency to be volatile

Based on both qualitative and quantitative criteria and rating committee process and tendency to be relatively less volatile

Quality

Generally note used for issuance business but for risk management for proprietary asset management

Use ratings for pricing and underwriting decisions

Intermediaries

Do not meet with model builders, who rely on public issuer data including stock prices

Meet with the rating agencies and explain their financials and outlook

Issuers

Use them for risk management, capital allocation, portfolio management

Use them for pricing, capital allocation, new issue marketing and secondary market trading

Investors

Credit Models Credit Ratings

RISK MANAGEMENT

BIS Use of Ratings for Capital Adequacy

BIS proposals would replace existing risk categories with a “standard” system that assigns corporate, bank, or sovereign borrowers to varying risk weights based upon their credit ratings from recognized “external credit assessment institutions”

Eligibility criteria for “external credit assessment institutions” is a sensitive subject

Discretion of national regulators in each country

Mapping process of ratings to default performance should be as transparent as possible over as long a time frame as possible

Consistent use of rating agency mappings across borders may be difficult to ensure in light of the national supervisory discretion permitted in these matters

Multiple ratings, to the extent available, may introduce elements of shopping for the highest rating rather than the most accurate

RISK MANAGEMENT

Credit Models Complement Ratings

Sophisticated mathematical techniques have been developed to measure credit risks, focusing on three key parameters and how they change:

Frequency of payments problems, including delinquencies and losses

Recoveries in the event of losses

Exposure of the company’s credit portfolio to certain credit events

These alternative risk measurement and management systems may complement traditional credit ratings

Could be useful for unrated credits

Could be useful for portfolio management

Could be useful for stress testing

Models can help improve a strong credit process to minimize losses but are no substitute

MAHESH K. KOTECHA, C.F.A.

Mr. Kotecha is President and founder of Structured Credit International Corp. (SCIC), a financial advisory firm with expertise in ratings and structured finance. Its clients include Inter-American Development Bank. Prior to forming SCIC, he was Managing Director of MBIA Insurance Corporation, of CapMAC Asia and CapMAC and an Alternate Director for ASIA Ltd. His previous responsibilities at MBIA included deal origination of all types of transactions and execution or corporate structured financings.

He came to CapMAC in 1989 from Kidder, Peabody, where he was Director of the Market Analysis and Product Development Group in the Asset Finance Department. Mr. Kotecha led Kidder into the UK mortgage backed securities markets, structured the first public Collateralized Bond Obligation (CBO), and advised International Finance Corporation (IFC) and Turkey on capital markets issues. Previously, Mr. Kotecha worked for eight years at Standard & Poor's, where he was responsible for all ratings based on non-US collateral: mortgage and non-mortgage. Earlier, Mr. Kotecha worked for four years at the Federal Reserve Bank of New York and for three years at the United Nations Fund for Population Activities (UNFPA).

Mr. Kotecha holds a Master's degree in management from the Sloan School of Management at MIT, and a Bachelor's degree in physics and engineering from Harvey Mudd College in Claremont, California. He is listed in Who's Who in America (1992 -). He is a member of the Council on Foreign Relations, East African Development Bank's International Advisory Panel, and the Board of Directors of Colombia’s BRC Investor Services (BRCIS).

THANK YOU

www.brc.com.cowww.4scic.com

Documents

Mahesh Kotecha, CFAMahesh Kotecha, CFA President, Structured Credit International Member of the Board of Directors, BRC Investor Services S.A Sociedad Calificadora de Valores Tel: