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Microsoft word - Концепция_201103_eng.doc

By the Resolution of the Board of
the National Bank of the Republic
of Kazakhstan
of «__»_______2003 #__
Mortgage Loan Guarantee System
1.Introduction 2.Necessity of Establishment of Mortgage Loan Guarantee System 3.Goals and Objectives of the Guarantee Fund for Mortgage Credit 4.Mortgage Loan Guarantee Basic Principles and Procedures 5.Mortgage Loan Guarantee Models 6.Advantages of Establishment and Development of Mortgage Loan Guarantee System 7.Necessary Conditions for Mortgage Loan Guarantee System Introduction and Development 8.Conclusion 1. Introduction
Worldwide the mortgage loan guarantee system played an important role in the mortgage market development. The mortgage loan guarantee (insurance) companies operate developed and dynamically developing economies, such as: USA, Canada, the United Kingdom, Italy, Spain, Sweden, Australia, New Zealand, Hong Kong, Israel, South Africa. Currently in Latvia, Poland, India, Thailand and a number of other countries the mortgage loan guarantee system is at its development and implementation stage. The macroeconomic and financial strength, successfully developing financial sector and mortgage market, adequate development level of legislative, administrative and technical infrastructure, efficient regulation and supervision of banking and insurance activities need to be assured in order to establish the mortgage loan guarantee system. The observance of these conditions enables Kazakhstan to optimize and expand mortgage lending to citizens by means of mortgage loan guarantee system establishment. 2. Need for Mortgage Loan Guarantee System Establishment
Despite quick tempos of the mortgage market development in Kazakhstan the mortgage loans to the citizens of Kazakhstan are available on a rather limited basis. The main restricting factor is the requirement for significant sizes of savings and incomes regarding making downpayment and monthly repayments on the loans due to comparatively short terms of mortgage loans and high interest rates. Determination of relatively stringent requirements to borrowers by the banks, which extend mortgage loans, is the response to the banks’ aspiration for the reduction of credit risks attributable to default. Hence, the determination of the banks’ margin on mortgage loans within the range of 3-4 percent will enable banks, extending loans, to cover their credit risks. According to the Framework of Long-Term Financing of Residential Construction and Development of Mortgage Lending in the Republic of Kazakhstan, approved by the Resolution of the Government in August 2000, the main measures on the diminishment of the credit risk (default risk) include the assurance of the real enforceability of foreclosure to the lender and sale of the pledged property, development of mortgage loan underwriting, designing procedures of providing and servicing mortgage loans. However these measures can not bring to the complete diminishment of the credit risk, because the lender is not insured against either cyclical or catastrophic economic conditions that result in increased risk of default or the volatility of the price level in the residential market and deviations from the stated price on the pledged property from its market price. In case of a significant decline in the housing price level or a significant depreciation of prices on housing pledged as security for a mortgage loan the lender may incur significant losses in case of a borrower’s default and subsequent disposal of the pledged property at a price, which is materially lower that the stated price upon the mortgage loan origination. The maximum LTV ratio at 70% enables to solve this problem to some extent, because it presumes the decrease in price for housing approximately by 30%. Additionally this requirement to mortgage loans significantly narrows the number of potential borrowers, taking into account that a borrower should pay 30% downpayment of the property value under acquisition. LTV increasing to 85% and higher will enable to attract new borrowers with more “moderate” savings. In par all this change will materially increase the lenders’ risks attributable to both the potential of default (which increases significantly as LTV increases) and the potential for a significant decrease in prices for housing in the future. However sharing of credit risks by means of guarantee (insurance) of mortgage loans and the increase of LTV will in reality presume the decrease of mortgage loan credit risks for lenders, what in future will be conducive to the elongation of loan terms and the decrease in interest rates, hence the expansion of the public access to the mortgage lending system. Currently the diminishment in the downpayment from 30% to 15% is attained due to the borrower’s liability insurance. By obtaining a mortgage loan with LTV higher than 70% up to 85% a borrower should insure his liability before bank concerning his payment of the remaining portion of the downpayment. This enables the expansion of the public access to mortgage loans but does not resolve in full the goal of credit risk decrease because liability insurance covers the lender’s risks up to 17.6% of the loan amount and only during the beginning period of the mortgage loan servicing until LTV reaches 0.7. The increase in the terms of mortgage loans from 15 years up to 20 years will enable to reach about 16% of the population. The reduction in interest rates on mortgage loans by 0.5 percent allows to amplify the access of the population to mortgage lending approximately by 4%, 1 percent – 10,5%, 1.5 percent – 17%. Parallel reduction of interest rates by 1.5 percent and the increase of the loan terms by 10 years will expand the access of public to the mortgage lending system almost by 1.5 times. The establishment of the mortgage loan guarantee (insurance) system or credit risk sharing shall be the next stage in the development of the mortgage lending system in Kazakhstan and also in the expansion of the list of services provided in the insurance market. 3. Purposes and Objectives of the Guarantee Fund for Mortgage Credit
The purpose of the establishment of Kazakhstan Guarantee Fund for Mortgage Credit (hereinafter “Fund”) is the increase in the supply of housing for the population by the expansion of access to the mortgage lending system and the improvement of its operations. The main objectives of the establishment and operations of the Fund are in the creation of favorable environment for the prolongation of mortgage loan terms, reduction of interest rates, increase in the loan amounts, diminishment of the downpayment and the formation of the mortgage loan guarantee (insurance) system and the relevant segment of the insurance market. Mortgage Loan Guarantee Basic Principles and Procedures
Main peculiarities of operations of an entity similar to the Fund worldwide are the high level of capitalization and monoline nature. The mandatory equity of entities, which guarantee (insure) mortgage loans is computed based on 20:1 (25:1) risk to capital ratio1. This requirement explains the high level of capitalization of entities, which guarantee (insure) mortgage loans and paid its way during the periods of financial crisis and depreciation of prices on real estate. The mortgage loan guarantee system is related to relatively high risks taken by an entity, which provides guarantee for mortgage loans. This capital can not be used for guarantee (insurance) of risks of other type therefore mortgage loan guarantee (insurance) entities provide services exclusively on guarantying mortgage loans (monoline) except for other services on mortgage loan guarantee or insurance. These requirements were created as a result of a number of financial breakdowns and are applied, in practice, in all countries. In order that the mortgage loan guarantee system function properly it is necessary to establish an entity with sufficiently high level of capital, which is currently is not feasible for private companies in Kazakhstan. The establishment of the Fund by the National Bank and its capitalization on the level, which is appropriate according to the international standards, shall be the initial stage of the mortgage guarantee (insurance) system development. The observance of 20:1 (25:1) risk to capital ratio and the monoline nature of services rendered shall be necessary requirements to the Fund’s operations. The Fund’s initial capital of 500,000,000 tenge (approximately $ 3.33 million) shall be sufficient for guarantying mortgage loans for approximately $135 million (13.5 thousand loans with an average mortgage loan size of $10,000). With the expansion of mortgage lending the requirements to the Fund’s owner’s equity will increase. In the long run due to sufficiently high requirements to the Fund’s capitalization there will be a necessity in attracting additional capital. The Fund shall be a self-supporting entity, the principal income of which shall be generated from the contributions as per the mortgage loan guarantee contracts. The sizes of the contributions should cover the Fund’s administrative expenses and also assure the creation and the maintenance of the reserves necessary for the lender’s estimated and contingent loss recovery. At the initial stage the Fund should have single (one-off) contribution model in order to accelerate the creation of the necessary reserve (Appendix, Table 3 and Table 4). Upon the accumulation of sufficient reserve regular (annual) contributions under mortgage loan guarantee contracts will be introduced. Contribution rates shall be revised depending upon the situation in the mortgage market, risk portfolio profile and the Fund’s financial position. The Fund shall be a non-for-profit organization, which does not consider profit generation as the primary objective. The accumulation of sufficient Fund’s reserve during the initial several years of operation will subsequently enable to reduce the sizes of contributions. According to the customary practice worldwide the premiums (tariffs) are paid by the borrower. The premiums may be paid up-front as a separate closing cost or added in the loan amount and amortized over the loan period. Alternatively, the premiums may be paid as annual or monthly installments, although this involves additional accounting burden. . The introduction of mortgage guarantee will enable to increase the loan to value ratio (LTV) or diminish the downpayment. It is proposed to increase the LTV from current 0.70 to 0.85, and prospectively to 0.90. However, in principle, the most important condition is that LTV should not reach 1.0, in order to assure the motivation of the borrower in the discharge of 1 In USA private companies should have a risk to capital ration of 20:1 and AA credit rating of one of the three recognized rating agencies in order to comply with Fannie Mae’s and Freddie Mac’s requirements. liabilities under the loan contract by means of paying in his own funds upon the acquisition or construction of housing. Requirements to lenders, borrowers, the pledged property and the quality of mortgage loans at the beginning stage will be based on carefully considered processes and examples from international best practice. With regard to underwriting individual loans, FGIC will develop standards consistent with the practices of the mortgage lending now taking place in Kazakhstan. The current requirements of Kazakhstan Mortgage Company (hereinafter “KMC”) with regard to loan acquisitions, will be one important input to developing the underwriting standards. However, FGIC will also insure loans that are soundly underwritten but may differ in some aspects from KMC parameters. FGIC will work with as many lenders as possible. Whether or not a lender sells loans to KMC is not a consideration in the underwriting standards or other procedures of FGIC. FGIC will undertake the responsibility to review any prudent underwriting guidelines used by the lenders, The introduction of the mortgage guarantee system will substitute liability insurance, because the mortgage loan guarantee presupposes the coverage of 50 % of credit risks within the total mortgage loan term up to 17.6% over the first several years of mortgage loan servicing, when the default risk is minimal. Additionally, in case KMC buys mortgage loans with LTV within the range of 0.70 to 0.85 exclusively with the availability of the Fund’s guarantee, the volume of guaranteed mortgage loans will be approximately 40% of KMC’s mortgage loans purchases. With regard to that part of the population which currently does not comply with KMC’s basic income or the income requirements of other prudent underwriting systems, , the underwriting criteria may modified as desired by FGIC with regard to the loans that FGIC agrees to insure. For example, the underwriting criteria may be made more “lenient” ” and provided that mortgage loans are guaranteed on a mandatory basis. As an example, in case the monthly loan repayment installments exceed 35% of the borrower’s aggregate income (and each member of the borrower’s household has not less than the determined income size the mortgage loan guarantee will be mandatory. . . For example, the upper limit of monthly payments on the loan of 45% of the aggregate borrower’s income may be increased up to 55%2. Adoption by FGIC and KMC of agreed requirements would allow a gradual increase in the volume of mortgage loan purchases by KMC and improve their quality through the Fund’s credit enhancement. In the event of an early repayment of a mortgage loan guaranteed by the Fund a definite size of contribution may be returned to the borrower. The rate of refundable (single) contributions will be higher that the rate of non- refundable contributions. The Fund’s reserves will be formed based on the allocation of 60% of the incoming contributions, which in the long-term perspective shall be adequate for the accumulation of necessary funds for potential loss indemnification. With regard to non-refundable contributions the allocations into the Reserve will be higher due to the potential of some portion of the contribution payback in case of an early repayment. 5. Mortgage Loan Guarantee Model
In the introduction of a mortgage guarantee system the financial institutions, which provide mortgage loans to public, will be able to diminish their risks attributable to the losses resulting from the borrower’s default on the loan and the non-possibility of their coverage from the pledged property foreclosure sale proceeds. The loss indemnification amount depends on the determined level of the guarantee coverage stipulated in the contract made between the lenders and the Fund. Worldwide the level of the 2 Currently commensurate to “Main Requirements to Residential Mortgage Bank Loans” the rights of demand to which are acquired by CJSC “Kazakhstan Mortgage Company” and Guidance on their Origination and Servicing” the adjustment of monthly payments to monthly income ratio (PTI) is permitted up to 45%. guarantee (insurance) coverage is within the range of 12% to 50% of the loan amount. The Fund’s guarantee coverage is proposed to be established at 50% the lender’s losses, which constitute the difference between the amount of claim (outstanding principal balance, delinquent interest, the lender’s property maintenance expense till the foreclosure sale, legal foreclosure expense, except for penalties and fines) and the selling price of the pledged property. Computation of “Guarantee Coverage”
Claim Amount in Case of Default (during the second Property Maintenance Costs (including property tax, Liquidation Value (55% of historical cost) Lender’s losses prior to Indemnification Minimal Single Contribution Rate of Loan Amount Minimal Annual Contribution Rate of Loan The contributions shall be computed for each level of the guarantee coverage. The contributions may be single (paid at the time of a mortgage loan origination) or regular (annual). The higher the level of the guarantee coverage the larger the contributions. More detailed data on the computation of contribution rates are presented in Appendix. While using this model it is sufficient to prolong the term of a mortgage loan for 2 years or reduce the interest rate by 0.7 percent (from 12.9% to 12.25% and lower) in order to assure
preference for the borrower of obtaining a loan, carrying guarantee. 50% sharing of bank credit
risks, extending mortgage loans, enables the banks to reduce the interest rates roughly by 1 –
1.5 percent
, which is practicable under the current competition among the banks. This
assumption is based on the following
During the period of active operations from July 2001 till November 2003 KMC acquired 3,410 loans for 5.6 billion tenge. The partner banks purchased back 7 loans, out of which only one loan was repurchased due to the reason of delinquency. According to the information available the pledged property was put up for auction, the expected selling price was 1.5 million tenge with the loan overdue amount of 0.5 million tenge. Hence as per the results of the two-year operations the credit risk on KMC’s loans equals zero. Accordingly the existent bank margin in the size of 3-4 % is fully used for the coverage of costs pertinent to loan servicing and generating profits by the bank. Alongwith, as it is evident from the experience of other countries the defaults on loans can occur, mainly, during 4 – 8 years of loan servicing. Default curves
Due to the fact that at the initial stage of the Fund’s operations a loss-sharing model will be applied it is necessary to retain the right of recourse on the mortgage loans, acquired by KMC. At the same time the guarantee, provided by the Fund on a mortgage loan will be effective commensurate to the provisions of the contract regardless of the fact who owns the right of demand on it. Gradual expansion of mortgage lending and mortgage loan guarantee will enable the Fund to become a fully self-sustaining entity during the third-fourth year of its operations (Appendix, Table 3). 6. Advantages of Establishment and Development of Mortgage Loan Guarantee
The introduction of the mortgage loan guarantee system gives significant advantages for the borrowers. The reduction of the size of the downpayment on the housing acquisition from 30% to 15% will attract into the lending system the portion of citizens, who do not have sufficient savings for complying with the existing mortgage lending requirements. Perspective increase of the terms and decrease in the interest rates on the mortgage loans will enable to diminish the sizes of monthly installments, what will positively affect the availability of mortgage loans for the population with moderate income and the increase in the mortgage loan amounts. The principal advantage of the introduction of mortgage guarantee for lenders is in the fact, that the credit risk sharing with the Fund will enable them to expand their credit portfolio due to the diminishment of the downpayment and the extension of loans to families with a more “moderate income. The mortgage loan guarantee system participating lenders will be more competitive due to the reduction of the interest rates on mortgage loans and the attraction of the population with an average income. The implementation of the mortgage loan guarantee system will be conducive to the amplification of KMC’s opportunities regarding the acquisitions of mortgage loans with LTV up to 0.85 under the condition of the availability of the Fund’s guarantee. The introduction of the mortgage loan guarantee system will contribute to the upturn in demand for housing, expansion of housing construction; development of related industries, job growth. The involvement of the population with moderate income, low savings, including young families and also the amplification of the residential market will contribute to the labor mobility within the country. 7. Necessary Conditions for Mortgage Loan Guarantee System Introduction and
In order to successfully introduce and develop the mortgage loan guarantee system it is proposed to introduce amendments into the regulation of mortgage loan guarantee (insurance) service providers, the methodology of the lender’s risk measurement. Due to the high risk of the mortgage loan guarantee (insurance) pertaining to the cyclic development of the global and national economy and also on the basis of the international experience strict requirements were developed regarding the companies, which provide such services. These requirements include, primarily, a high capitalization level, compliance with the minimal capital requirements, 20:1 (25:1) risk to capital ratio, “monoline” organizational structure (provision of one type of services). In order to assure the competitive environment and bringing to international requirements it is necessary to set the above said requirements for Kazakhstan organizations, which guarantee (insure) mortgage loans. Besides, these organizations should not be affiliated with an organization, which extends mortgage loans. The existing liability insurance is also the insurance of mortgage loans, where the insurers cover up to 17.6% lending bank’s credit risks during the first several years of loan service term, i.e. until LTV reaches 0.70 (for a 15-year loan this period lasts during 5 beginning years). In this connection some portion of capital should be allocated for the insurance of mortgage loan credit risks in connection with insurers, which provide liability insurance. This portion of capital should be used for the insurance of mortgage loans in case of compliance with 1:20 risk to capital ratio. Therefore requirements employed in the international practice regarding adequate capitalization and the monoline nature of the insurance company will be observed. Worldwide, in the evaluation of the bank’s owner’s equity adequacy the availability of the guarantee (insurance) of mortgage loans is verified. The requirements to guaranteed loans with high LTV are significantly lower that those to non-guaranteed loans with the same LTV level. The National Bank should change the risk weight policies in the following manner: for guaranteed loans with LTV higher than 0.70 (and based on compliance with KMC’s requirements) establish the risk weight at 50% and for non-guaranteed loans with LTV higher than 0.70 – 100%. This requirement adopted in accordance with the international standards shall be one of the conditions for successful implementation of the mortgage loan guarantee system. One of the critically important conditions of the mortgage loan guarantee system shall be the modification of Kazakhstan Mortgage Company’s requirements to mortgage loans with regard to the mandatory obligation introduction regarding the availability of the Fund’s loan guarantee: the size of which exceeds the determined limit; extended to borrowers, who do not comply with KMC’s essential requirements regarding the income level. 8. Conclusion
The presence of a competitive banking sector and the mortgage market in Kazakhstan shall be an important condition for the establishment of the mortgage loan guarantee system. Based on the world practices the provision of guarantee on the mortgage loans shall be one of the most efficient tools in the expansion of mortgage lending to citizens. Additionally the implementation and development of the mortgage loan guarantee system enables to observe interests and benefits of the public and entities, which extend mortgage loans and the economy, in general. Appendix
Basic Assumptions in Contribution Rate Computation
Optimistic Realistic Pessimistic Scenario
Scenario Weights
0.25 0.5 0.25 1
Loan Characteristics
Underwriting Expense
Initial Underwriting Expense (as % of loan amount) Current Underwriting Expense (as % of loan amount) Indemnity costs
Number of Delinquent Loan Payments in Months Taxes and Delinquent Property Insurance Premiums (as % of value) Foreclosure Sale of Property upon Default (as % of initial value) Mortgage Loan Contribution Rates
Single Annual Single Annual Single Annual Single Annual Single Annual
Forecast of Main Financial Indicators of the Guarantee Fund for Mortgage Credit
(single contributions)
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 TOTAL
284.5 533.8 588.3 648.4 714.6 787.5 868.0 956.6 1,054.2 1,161.9 7,597.8 -353.0 -389.0 -428.8 -472.5 -520.8 -573.9 -170.7 -318.1 -340.4 -352.3 -354.4 -354.1 -359.4 -384.3 113.8 215.7 247.9 296.0 360.1 433.5 508.6 572.3 630.8 695.2 4,074.0 157.7 161.4 177.9 195.2 212.8 230.6 248.4 267.0 287.2 309.4 2,247.5 271.5 377.1 425.8 491.2 573.0 664.0 756.9 839.3 917.9 1,004.6 6,321.5
374.3 349.6 363.6 399.9 444.2 458.6 512.4 564.7 615.9 640.5 4,723.7 30.4 24.3 19.5 10.0 10.0 7.7 8.4 9.6 10.4 10.8 Total Expense, in US dollars
435.1 398.3 402.6 429.9 469.2 477.9 533.5 588.6 641.8 667.5 5,044.4
Profit/Loss, in US dollars
103.8 186.1 223.5 250.7
Number of new loans (7-year, in average), covered by the Fund’s guarantee Volume of new loans, in thousand US dollars 16,940 31,785 35,030 38,606 42,548 46,892 51,680 56,956 Average rate of contributions for 7-year loans 1.68% 1.68% 1.68% 1.68% 1.68% 1.68% 1.68% 1.68% 1.68% Percent of deductions of contributions into Reserve Fund Forecast of Main Financial Indicators of the Guarantee Fund for Mortgage Credit
(annual contributions)
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Year 9 Year 10 TOTAL
64.9 186.7 321.0 468.9 632.0 811.7 1,009.7 1,163.1 1,216.9 1,161.0 7,035.8 12.6 36.7 74.3 118.5 161.4 189.7 209.1 230.4 1,034.9 167.6 151. 158.8 169.4 183.1 199.9 220.3 244.1 269.8 294.5 2,058.9 193.6 228.4 299.7 393.6 510.2 643.1 785.5 899.0 965.6 989.3 5,908.1
336.2 349.6 363.6 399.9 444.2 458.6 512.4 564.7 615.9 640.5 4,685.6 Total Expense in US dollars
397.0 398.3 402.6
477.9 533.5 588.6 641.8 667.5 5,006,3
Profit/Loss, in US dollars
-203.4 -169.9 -102.8 -36.3
Number of new loans (7-year, in average), covered by the Fund’s guarantee Volume of new loans, in thousand US dollars 16,940 31,785 35,030 38,606 42,548 46,892 Average rate of contributions for 7-year loans Percent of deductions of contributions into Reserve Fund


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