G. Administrative
costs. Agencies are asked to estimate the annual expenses directly
associated with administering the loans outstanding on September
30, 1995. Administrative costs should be defined consistent with
OMB Circular No. A-11, Section 33.5(n).
Agencies may use Method
I: their own methodology for projecting administrative expenses
or Method II: the methodology contained in the Lotus spreadsheet
("port_val.wk3") which accompanies this guidance. Method II relies
on per loan costs in FY 1995 for projecting future administrative
costs. If using Method II, agencies must:
(1) estimate the
number of loans outstanding each year until maturity;
(2) project the
net growth in administrative expenses (rising wages, productivity
gains, and other factors should be taken into consideration);
and
(3) project the
percent of substantially performing loans as of September 30,
1995, that will become non-performing each year.
Agencies may modify
Method II to more accurately reflect the expected annual administrative
costs of their outstanding portfolios on September 30, 1995.
4. Comparison of
cash flow projections. Using the data provided by agencies,
OMB will compare: (1) the net present value of the Government's
expected cash flows and administrative expenses, to (2) the expected
net proceeds from selling the loans to the private sector, which
is the net present value of the projected cash flows if the loans
were sold to the private sector. Consistent with the estimation
of loan modification cost (as defined in OMB Circular No. A-34,
Section 65.3), Governmental cash flows will be discounted at the
"applicable interest rate (yield) in the quarter when the modification
occurs." For the purposes of this analysis, present value calculations
will assume the Government's loan portfolio was sold to the private
sector on September 30, 1995. Calculating the values as of the
end of FY 1995 will minimize the assumptions underlying this analysis,
such as the size of the portfolio outstanding and appropriate
discount rates.
5. Due Date.
Estimates should be delivered to the OMB examiner with primary
responsibility for the credit account using this spreadsheet by
February 9, 1996.
Alice M. Rivilin
Director
Attachment
C
21.
LOAN ASSET VALUATION
Introduction
In compliance with
the report language accompanying the Treasury-Postal Appropriations
Act of 1996 (P.L. 104-52), this chapter reviews the Government-wide
potential for loan asset sales. It summarizes the Government's
loan asset sales in the 1970s and 1980s, describes the current
budgetary scoring of loan asset sales, and enumerates the agency
loan asset valuation data requested by OMB for this analysis.
The following section reviews the value of Government loan assets
and identifies factors to be used in reviewing potential sale
opportunities. The final section describes ongoing loan asset
sales, and assesses loan programs' potential for profitable sale
to the private sector.
This evaluation of
the Government's loan portfolios has identified a number of programs
that could potentially be sold to private investors at no cost
or a profit to the Treasury. Loan asset sales are not recommended
on a large scale, as in prior years, in part because costs to
the Government often exceed returns. This is now reflected in
budgetary scoring rules enacted as part of the Federal Credit
Reform-Act of 1990 (FCRA).
Previous
Loan Asset Sales
1970s to mid-1980s.
Federal direct loan assets were sold to the public producing over
$40 billion in proceeds in the 1970s and early 1980s. In these
sales, a guarantee by the selling agency (recourse) was often
attached. After the sale, the loan was held privately but the
risk of default in the recourse sales remained with the Government.
In some cases, the Federal agency sold securities [called participation
certificates (PC's) or certificates of beneficial ownership (CBO's)]
that were backed by loans that the agency continued to hold and
service.
1987-1990.
During the late 1980s, a series of pilot loan asset sales were
undertaken, resulting in the sale of nearly $25 billion of Federal
loan assets. In the President's 1987 budget, the pilot program
was first proposed, with the following four objectives: (1) improve
credit management; (2) obtain administrative savings; (3) identify
subsidies; and (4) reduce the short-term deficit.
Loan asset sales were
seen as a tool for improving public sector credit management.
Asset sales provided an incentive for agencies to improve loan
origination and documentation, because loans could be sold at
a higher price if screening and documentation met private sector
standards. Sales also provided information on the condition of
loan portfolios, revealing areas of improvement for servicing
of agencies' remaining portfolios. Second, loan asset sales allowed
the Government to reduce its administrative costs by transferring
servicing and collection to the private sector. Third, nonrecourse
sales of new loans provided information regarding the subsidies
of Federal credit programs. The difference between face value
and selling price (net of transaction costs) was the Government's
subsidy cost. Finally, loan asset sales generated proceeds to
increase budgetary offsetting collections in the year of the sale.
The sale of Education,
HUD, USDA, and VA loan assets produced gross proceeds of $5.6
billion in 1987, $8.2 billion in 1988, and a total of $10.5 billion
in 1989 and 1990. However, the cost to the Government of these
sales was substantial, with sale proceeds averaging less than
90 percent of the present value of the Government's cash flows.
Improved management of the unsold portfolios was expected to partially
offset losses resulting from the loan asset sales.
Budgetary
Scoring of Loan Sales
Prior to 1987, loan
asset sales were treated as offsets to agency outlays (equivalent
to loan repayments) for purposes of budget scoring. Thus, sale
proceeds were permitted to offset increased spending. Despite
the fact that asset sales might result in a present value loss
to the Government (due to the loss of future cash flows), sale
proceeds were allowed to offset spending in the year in which
the sale occurred.
Amendments to Gramm-Rudman-Hollings
(GRH) in 1987 allowed only those proceeds from routine and ongoing
sales established prior to 1987 to offset spending, or to offset
the deficit for the purposes of sequester calculations. Thus,
newly proposed loan sales could not be considered as an offset
to spending for budgetary scoring purposes because such sales
were not viewed as reducing the structural deficit.
Under the Federal
Credit Reform Act, loan asset sales are treated as modifications
that change the cost of the loan or guarantee, and are not undertaken
unless budget authority has been provided for any positive subsidy
cost of the sale. The 1996 Budget Resolution (Sec. 206 of H.Con.
Res. 67) confirmed this budgetary treatment of loan sales under
credit reform.
As modifications,
the credit reform subsidy cost of a loan asset sale is the difference
between the Government's currently estimated net present value
(NPV) of the remaining cash flows under the terms of the existing
loan contract (the "expected" value), and the net proceeds from
the loan sale. The result of this calculation can be positive,
negative, or zero. If the estimate is positive, i.e., the expected
value to the Government is greater than the loan sale proceeds,
budget authority must be provided to cover the additional subsidy
cost resulting from the sale. A negative estimate would indicate
that the Government is achieving a savings from the sale, and
a receipt in the amount of the "negative subsidy" is generated
from the sale. An estimate of zero would indicate that the modification
will not change the cost to the Government, and budgetary resources
would not change.
If the loan assets
sold prior to 1990 had been scored under credit reform, not only
would the sale proceeds not have been available to offset spending
in the year of the sale, but an appropriation would have been
required to cover the loan modification cost for those loans sold
below the Government's expected value. By scoring loan sales as
modifications, agency actions are subject to greater scrutiny
by Congress and OMB. This scrutiny prevents costly sales, and
encourages and gives credit to agencies for sales that save Federal
resources.
The FCRA definition
of subsidy cost specifically excludes administrative costs and
any incidental effects on government receipts or outlays. For
loan sales, this means that effects on Federal administrative
costs and incidental changes to interest on the public debt are
excluded from the subsidy cost calculation. For some agencies,
loan sales would produce savings from reduced administrative (personnel)
costs for loan servicing, management, and delinquent debt collection.
Although not scorable for budgetary purposes, these savings should
be considered when evaluating the total effect of a loan sale;
they would lower the agency's future administrative expense requests.
For other agencies, selling loan assets would relieve staff of
the administrative burden of loan servicing, allowing them to
be redirected to other programs. Although this would not produce
savings from a reduction of personnel, it could serve to enhance
the mission of the agency.
Potential
for Further Loan Asset Sales
The recent success
of HUD loan asset sales has sparked renewed interest in Government-wide
sales. In the Treasury-Postal report language, the conferees directed
OMB "... to direct, and coordinate with, the Federal agencies
involved in credit programs to evaluate the value of their credit
programs ... and develop a plan for the privatization of such
credit programs."
In response to this
request, for all direct loans, loan guarantees, and defaulted
loans that were previously guaranteed and have resulted in loans
receivable, OMB requested that agencies provide (1) the face value
of loans outstanding as of September 30, 1995, (2) the currently
expected cash flows to the Government, and (3) estimated cash
flows to the private sector (if those loan assets were sold).
To calculate whether the sale of these loans would result in an
estimated net saving to the Treasury, for each loan portfolio
when possible, the net present value of the Government's remaining
cash flows were compared to the NPV of the expected cash flows
to the private sector, adjusted for the private sector's administrative
costs and the transaction costs of a loan asset sale. The private
sector's servicing costs must be included as a factor in estimating
the market value that they would be willing to pay for a given
stream of cash flows, because these costs are not included in
the Government's cash flows. The transactional costs take account
of the difference between the gross and net proceeds to the Government.
Expected cash flows to the Government were discounted at the rate
on Treasury securities of comparable maturity to the remaining
portfolio maturity, as required by Sec. 502(5) of the Federal
Credit Reform Act. As discussed below, expected cash flows to
the private sector were discounted by the appropriate private
sector rate. Table 8-1 contains the Government's expected cost
of new loans and its outstanding portfolio.
To allow for the comparison
of the value of different types of loan assets, OMB asked agencies
to divide outstanding portfolios into two categories: substantially
performing and non-performing. Substantially performing loans
were current or delinquent less than 90 days as of September 30,
1995. Non-performing loans were those delinquent for 90 days or
more. In addition, agencies were asked to provide information
on the Government's administrative costs.
This analysis is subject
to severe limitations because of its broad scope, the short time
period for collecting and analyzing data, financial systems constraints
in obtaining data, and the difficulty of estimating private sector
valuation of loan assets. As a result, this report serves only
to identify loan programs which show potential for loan asset
sales or which clearly cannot be sold to the private sector without
substantial financial and/or public policy costs to the Government.
While the analysis narrows the field of potential candidates for
loan asset sales, further analysis is planned to identify the
potential benefit of asset sales in the remaining programs.
Private
Sector Valuation of Federal Loan Assets
The value of Federal
loan assets to the Government and private sector may differ substantially.
Some costs, such as subsidized interest, are valued similarly
by the Government and private investors. Other non-contractual
expected costs may be valued very differently. For example, given
their relative efficiencies and collections tools, the Government
and private investors may have dramatically different estimates
of future defaults and recoveries. Before deciding to bid on Government
loan assets, the private investor must adjust the expected value
to the Government for the investor's higher discount rate, expected
efficiency gains, and the cost of servicing loan assets.
Discount
Rate
When the Government
provides a loan, it contracts to receive a stream of payments
of principal, interest, and often fees. It also expects to experience
defaults. The "value" of this loan to a potential private sector
investor is the present value of the expected net cash flow to
the private sector, where the discount factor the private sector
discount rate. This rate will be higher than the Government's
discount rate for at least four reasons: a higher cost of funds,
private sector risk aversion, desire for liquidity, and information
requirements.
- Cost of
funds: The private sector's cost of funds, the base
discount rate, is higher than the Government's discount rate,
which is the rate on Treasury securities of comparable maturity
to the outstanding loan. Therefore, even before adjusting for
risk, liquidity, and information concerns, the private sector's
discount rate for valuing loan assets will always be higher
than the Government's.
- Risk:
Investors associate a range of risk with the Government's default
estimates for loan assets. Investors are usually considered
risk averse; that is, they would prefer to receive $90 with
certainty than to receive $100 with a default probability distribution
for which the mean is 10%. Because the amount received could
be less than $90 in the latter case, private investors will
require a premium to compensate for bearing this risk. The Government
has no counterpart for this cost; it incurs outlays only if
defaults are actually higher.
- Liquidity:
Because the market for Federal loan assets is small, it is not
very liquid. Unlike U.S. Treasury securities, for example, investors
cannot count on being able to sell the loan assets they purchase
quickly and at an attractive price. They require a premium to
compensate for this illiquidity.
- Information:
Finally, investors are not fully informed about Federal loan
assets. Because the Federal programs have different rules, documentation,
and collateral, investors must devote considerable time to acquiring
information about potential investments. These are not standard
commercial loans, and the Government's documentation methods
differ significantly from private entities'. Investors look
for systematic and predictable cash flows as shown by accurate
historical records of the portfolio's delinquency, default,
and recovery experiences, which Federal agencies are often not
able to provide. Investors require a premium to compensate for
these information costs.
These costs can never
be eliminated, but small reductions in premiums could be expected
if investors became more familiar with Federal loan assets, and
if the liquidity of their market improved.
Efficiency
Gains
Although the private
sector will use a higher discount rate than the Government, the
net cash flow to the private sector may be larger. It is generally
felt that the private sector is more efficient at loan servicing
and collection. For example, the loss rate on private commercial
loans is much lower than the loss rate on Government business
loans.
Such comparisons,
however, are difficult at best. In many ways, Government loans
are fundamentally different from private sector loans, and comparing
the two without taking into account their differences is misleading.
For example, the Government often functions as a lender of last
resort and makes loans to less creditworthy borrowers than would
a private lending institution. In addition, the terms of Government
loans, such as lower down payments or less restrictive underwriting
criteria than required in the private sector, may result in higher
defaults. Finally, other characteristics of Government lenders,
such as willingness to practice substantial forbearance, may increase
both the administrative and default costs.
A portion of the difference
in default costs is certainly due to these differences between
public and private sector loans. A portion of the difference may
also be due to the Government's relative inefficiency. Private
firms' profit motive creates the incentive for the private sector
to be more efficient than the public sector in performing common
tasks. However, for some programs, the Government's superior collection
tools, such as the IRS Tax Offset, may counterbalance private
sector productivity gains.
Decision
to Purchase Government Loan Assets
Private investors,
bidding on Government loan assets, will take into account the
Government's expected future losses and make assessments as to
how much they can reasonably expect to lower these losses. The
amount possible will depend upon how much more efficient the investors
expect to be at performing the required tasks.
Whether the value
of the loan asset to the private investor exceeds the value to
the Government depends on: (1) the difference in discount rates;
(2) the private sector's expected efficiency gains; (3) the private
sector's administrative costs; and (4) the loan asset sale transaction
costs. Because the private sector discount factor is higher than
the Government, the value of the loan asset to a private sector
investor will be lower than the value to the Government for a
given set of cash flows. On the other hand, because the investor
expects to reduce default costs below those of the Government,
the investor's valuation of the loan asset may be greater, because
expected cash flows will be higher.
Finally, for the Government
to receive sale proceeds greater than its expected value, these
proceeds must be greater than the Government's expected value
after sale transaction costs are paid. Therefore, the private
investor's productivity gains must not only cover its higher discount
rate and servicing costs, but must also allow for payment of the
sale transaction costs. These can be substantial, and include
the cost of a financial advisor and the costs of issuance.
Identifying
Loan Assets for Possible Sale
Decision
Analysis
The Treasury/Postal
conferees directed OMB to identify those loan assets which can
be sold at a gain to the Government. Based on past sales experience
and the review of the Government's current portfolio, OMB believes
that a percentage may be sold at a net profit to the Government.
The preliminary data recently received from the agencies will
allow OMB to begin the process of identifying which sales would
benefit the Government. The following framework allows for the
identification of those loan programs for which sales may result
in a net profit, or other type of gain, and develops a method
for identifying those programs which may merit further analysis.
This framework also outlines factors which would discourage private
investors from offering at least the Government's expected value
for certain loan assets. If loan assets are only to be sold at
no cost or a "profit" to the Government, loan portfolios with
these characteristics should not be considered further for loan
asset sales.
Factors
which May Lead to the Decision to Sell Federal Loan Assets
Efficiency
in Administration of Loan Portfolio. If an agency has
a dramatically expanding loan volume or a surge in defaults, it
has several options for avoiding a reduction in its servicing
and liquidation capabilities, including: continuing to hold the
loans and requesting additional staff for administration; attempting
to administer the loans with current staff levels; contracting
to the private sector for servicing; requiring guaranteed lenders
to work out the loans they originate; and selling the loans. With
declining staff levels in many agencies, a loan sale in these
cases may produce benefits for the Government apart from any immediate
"profit" from the sale. That is, even if these loans are sold
at the Government's expected value, the selling agency might guard
against deterioration in its loan servicing and liquidation capabilities.
In programs where
defaults surge briefly or are expected to grow in the future,
pilot loan sales may help the Government make decisions concerning
whether to add resources for program administration or sell the
loans. For example, recent dramatic growth in certain Federal
guarantee programs is expected to lead to large defaults in the
near future. Unless steps are taken soon, current administrative
resources may be insufficient to continue to adequately service
these loan portfolios. Testing the market, by selling loan assets
in a pilot program before the expected increase in defaults occur,
could help the Government decide whether it is more efficient
to add more debt collection staff and upgrade current financial
systems, to contract out loan servicing, or to sell defaulted
loans.
Best Use of
Federal Staff. Selling loans could prove useful for expired
programs, where no new loans are being issued, but staff time
is consumed with administration of the dwindling portfolio. Loan
sales may be warranted if current loan staff could be redirected
to focus attention on new or different lines of business that
are high priorities for the agency.
Private Sector
Practices. The private sector can be expected to pursue
non-current loans more aggressively because of the profit motive.
This is part of the reason for the "productivity gap" referenced
in the conference report requiring this study. Where Federal loans
are inefficiently managed, or funds for management of these programs
are declining, selling loans may capitalize on the quality of
servicing and liquidating practices in the private sector, and
provide a net benefit for the Government. The recent HUD sales
have shown that the private sector is willing to pay more for
loans where it believes that it can achieve these efficiencies
in servicing.
Collateral
Value. Loan sales may be warranted if collateral underlies
the loan and the private sector is better at maintaining collateral
value while in inventory, can dispose of it more quickly, or expects
a higher collateral sale price. Collateral value was an important
factor in the success of the recent HUD loan sales.
Public-private
Partnerships. In this era of reinvention, loan sales
foster new communication between the managers of the federally
assisted credit portfolio and the private credit market. This
partnership can serve to create new products or efficiencies that
can be applied across all credit programs. For HUD, this has meant
the creation of a user-friendly, low-cost due diligence process
that, combined with the use of computer technology, has attracted
a large following of investors with more than 200 bidders representing
a wide spectrum of the financial markets to their loan sales.
This new technology can be evaluated and the Government can assess
whether it could be useful to other Federal credit programs, or
for future loan sales.
Factors
which May Lead to the Decision to Hold Federal Loan Assets
Small Margin
for Improvement in Default Rates. When the private sector
has little margin for improving on the Government's expected net
defaults, it would not be profitable to sell the loan asset. This
includes both programs with a low life-time default rate and seasoned
loans with few remaining expected defaults. Since investors need
substantial efficiency gains to overcome their higher discount
rate, servicing costs, and the transaction costs of the loan sale,
unless the Government expects substantial future losses, opportunities
do not exist for the private sector to obtain sufficient productivity
gains. A number of Federal programs have historical default rates
of less than 5 percent. For example, the USDA's rural water and
waste loans have expected default rates of less than one percent,
leaving little room for the private sector to improve in this
expected performance.
Collection
Tools. The Federal Government has a variety of collection
tools that are not available to the private sector. These tools
include the IRS -Tax Offset, Federal Salary Offset, and the ability
to withhold future benefit payments (grants) and credit. Tax Refund
Offset and wage garnishment are extremely important to Collections
in the Federal student loan programs. A 1987 Chemical Bank analysis
of the marketability of student loans held by the Department of
Education concluded that the portfolio of loans was more valuable
to the Federal Government than to the private sector because of
the collection tools that are only available to the Government,
and because the private market would require a deep discount due
to the credit risk of these loans. For defaulted student loans
made under the health education assistance loan program, the Federal
Government can withhold Medicare payments until a doctor's (borrower's)
loan is in good standing.
For international
loan programs where loans or guarantees are made to another sovereign
government, the Government has a number of tools not available
to the private sector. These tools include international treaties
and agreements that the U.S. has signed with other nations and
the ability of the U.S. to block credits from international financial
institutions to debtor nations that have not honored their debt
obligations to the U.S. For example the Brooke Amendment and Section
620(q) of the Foreign Assistance Act make countries ineligible
for certain types of foreign assistance unless they make required
payments on their related debts to the U.S.
Policy Goals
of Domestic Programs. The Federal Government often uses
loans as tools to implement domestic policy objectives. In these
cases, the political goals of the program override the importance
of individual loan performance. Because of these policy goals,
Federal credit agencies often originate and service loans differently
than a private financial institution. Credit review takes secondary
importance to policy considerations, such as guaranteeing that
credit is available for all farmers or all students.
Likewise, servicing
actions in these programs and decisions on restructuring loans
may be aimed at providing additional assistance to the borrower
rather than at collecting funds promptly. For example, many farm
loan contracts contain significant borrower rights that make servicing
labor-intensive. These procedures to protect the borrower would
cause private sector purchasers to discount the value of these
loan assets heavily. It would be difficult for the Government
to continue to achieve its public policy objectives unless its
generous collection and forbearance tools were continued by the
private sector. However, if the private sector continued these
servicing and liquidation policies, it would be difficult to realize
the productivity gains necessary for a private investor to purchase
the loan assets at or above the Government's expected value.
Subsidies are not
necessarily limited to beneficial loan terms and collection procedures.
The Government may support the borrower by providing extensive
training, counseling, and technical support. For example, SBA's
Microlending Program avoids substantial defaults by providing
the micro-loan borrowers with the knowledge and skills they need
to successfully repay their loans. If these loans were sold, it
is not clear how the borrower-Government-investor relationship
would continue.
Foreign Policy
Goals and Considerations. Foreign policy goals and considerations
affect the provision and administration of Federal credit in that
they often offer terms and conditions that are more generous than
the private sector.
In some cases, foreign
policy goals could also inhibit purchases by the private sector.
For example, many loans are made to developing countries that
are perceived too risky for the extension of private credit. This
perception of risk is one of the justifications for the development
of some of the Government's international credit programs. In
other cases, the private sector might avoid credits that otherwise
would be attractive because of foreign policy sensitivities. For
example, the Department of Defense's new commercially-oriented
military export credit program was created by Congress partly
because the private sector has been reluctant to provide credit
for military export purchases.
The majority of outstanding
international direct loans and loan guarantees are sovereign;
that is, they are direct loans or loan guarantees that are to,
or guaranteed by, another sovereign government. It is unlikely
that a credit to a sovereign government would have a greater value
to the private sector than to the U.S. Government. Private sector
creditors remember the international debt crisis of the 1980s,
where a number of U.S. financial institutions lost large amounts
of funds that they had extended through loans to sovereign Governments
in developing countries. As a result, private creditors have since
often shied away from providing sovereign credit in most developing
countries. In addition, many of the sovereign direct loans that
are outstanding to the U.S. Government have been rescheduled in
the Paris Club, an informal group of creditor nations which agrees
to extend the maturity of loans that a debtor nation could not
otherwise pay on schedule. While Paris Club reschedulings are
done in order to increase the eventual probability of repayment,
because previously rescheduled loans are eligible for further
rescheduling, the private sector often views these loans as "subordinate"
to those that have not been rescheduled.
Length of
Loan Term. Some Federal programs have loan terms of 40-50
years. In these cases, the private market would view the extended
term as increasing the uncertainty of repayment, as well as exposing
them to additional interest rate risk. These factors would cause
the purchase price to be discounted heavily.
Lack of Private
Interest. Several factors may lead to the lack of interest
in Federal loan assets. These include: insufficient documentation;
lack of collateral pledged for the loan; inadequate information
regarding historical loan performance; and the lack of uniform
loan characteristics. In many programs, including rural development
ana farm loans, portions of existing loan origination and servicing
are not automated; and, therefore, the pre-sale due diligence
costs would be high. This lack of loan information and documentation
would also inhibit a rating agency from arriving at an accurate
rating for a pool of loans.
Legal Restrictions
or Other Complications. Many international loans and
guarantees have legal or contractual restrictions that would make
it difficult or impossible to sell them to the private sector.
For international loan guarantees to private borrowers, for example,
the Government pledges its "full faith and credit" in the contract
with the borrower and/or the lender. In these cases, the agency
involved would first have to "buy out" the holder of the U.S.
Government guarantee, by making a payment in lieu of responsibility
for future claims, in order to relieve the Government of the responsibility
of the original guarantee. This would be the case for the guarantee
programs of OPIC, where a11 loans are made to the private sector,
as well as with the non-sovereign portions of guarantees issued
by Eximbank and AID.
Programs
Currently Selling Loan Assets
Two programs currently
sell loan assets, the Federal Housing Administration and the Veterans
Administration. As with the other programs, these programs will
be evaluated using the criteria above as part of the ongoing analysis
of loan sales.
Federal Housing
Administration. FHA has been insuring mortgages since
1934. Historically, the program default stream has been relatively
predictable. However, during the 1980s weak real estate markets
prompted an unexpected surge of defaults in both the single family
and multifamily portfolios. By 1994, when the wave of defaults
subsided, FHA owned nearly 2,400 defaulted mortgages, with unpaid
principal balances of more than $7 billion, and 90,000 single
family mortgages with unpaid principal balances of almost $4 billion.
This volume was so large that it was compromising FHA's capacity
to perform its other functions (including oversight and management
of the of the insured mortgages in force), thereby making FHA
more vulnerable to future losses.
In response to this
large administrative burden, Congress and the Administration approved
a program to sell these HUD-held mortgages in a series of competitive
auctions and negotiated sales with state and local housing finance
agencies. These sales have been highly successful, helping HUD
reduce its inventory of mortgages, while capitalizing on the private
sector's knowledge and ability to manage defaulted loans. In an
improvement on earlier loan asset sales, the return to the Government
was increased through use of competitive bidding and computer
technology which evaluates and optimizes competing bids.
Department
of Veterans Affairs. The DVA "vendee" loan program provides
direct loans to veteran or non-veteran purchasers of DVA-owned
real property to facilitate property sales. Nearly all of these
direct loans are pooled and sold to the public with a Government
guarantee (recourse). In 1995 total proceeds from DVA loan asset
sales were $1,333 million.
Programs
which Merit Further Analysis of Loan Asset Sale Potential
Small Business
Administration. As a result of significant portfolio
growth since 1990, with no change in expected default rates, the
SBA can expect an increase in the number of defaulted loan guarantees
which will result in loan receivables. Further analysis is needed
to determine whether loan asset sales might be an effective tool
for alleviating the expected pressure on SBA's servicing and liquidation
offices, and for increasing recoveries. It is not clear how the
private sector would value these small business loans in comparison
to the Government's expected value. Unlike housing loans, which
have uniform terms and collateral, SBA guaranteed loans have a
wide range of purposes and varying collateral requirements.
SBA disaster loans
should also be more closely reviewed to determine whether the
sale of these loans assets could result in a net gain to the Government.
Since these are fixed-rate subsidized loans, the value of these
loans assets will be sensitive to the prevailing interest rates.
Eximbank.
Project finance and short-term insurance and working capital guarantee
claims are areas which merit further review. The project finance
program offers financing for the U.S. export component of major
overseas projects. While the typical pre-completion political
risk guarantee is not likely to be attractive to the private sector,
the subsequent loan or guarantee might be, particularly since
the riskiest part of the project, the construction phase, will
have been completed. The resulting savings in administrative expenses
could be considerable, since project finance tends to be a labor
intensive activity. However, these decisions would have to be
made on a case-by-case basis, since each project has a different
structure and therefore a different risk determination.
Eximbank extends between
$4 and $5 billion each year in short-term trade finance insurance,
and in working capital guarantees for small business
exporters. Eximbank attempts to limit its extension of insurance
and guarantees to cases where the private sector will not provide
coverage. However, once claims are paid, the recovery of these
claims is a task where Eximbank, as a Government agency, may not
have significant advantages over the private sector. In addition,
claims recovery can be relatively labor intensive, and the sale
of certain claims by Eximbank, even at a loss compared to the
expected value to the Government, in certain cases might be outweighed
by this gain in administrative savings.
Defaulted
Guaranteed Loans and Non-Performing Loans. In addition
to reviewing the SBA and Eximbank programs specified above and
analyzing more closely the ongoing HUD and VA sales, the potential
for selling defaulted guaranteed loans and non-performing loan
assets across agencies will be examined more closely. These loans
offer a special case where efficiency gains could be large. If
credit programs have low recovery expectations on such loans,
then the private sector may be willing to offer a price higher
than the Government's expected value.
Programs
where Loan Asset Sales Are Not Suitable
Departments
of Agriculture and Interior. Many of these loan programs
have significant borrower rights that would transfer with the
loan upon sale and would cause the proceeds to be significantly
discounted. They also often have loan terms of over 35 years.
This increase in uncertainty would be reflected in the sale price
of the loans. Finally, since most of the existing servicing is
not automated, due diligence costs would high.
Departments
of Education and Health and Human Services (HHS). The
Department of Education sold most of its low-interest college
housing and higher education facilities loans at a discount in
the late 1980s. A small number of the facilities and housing loans
it still holds are in default, and many of these schools have
negotiated payment arrangements with the Department or are in
formal foreclosure proceedings, which would preclude sale of their
loans. Those housing and facilities loans that are in good standing
have extended maturities and low expected default rates, which
makes it unlikely that the private sector would be willing to
offer a price higher than the Government's expected value. Direct
student loans and defaulted guaranteed loans at Education and
HHS are uncollateralized loans, which the market would discount
highly because of the uncertainty of collection. The Departments
also make considerable use of Federal Government collection tools
which are not available to the private sector. For example, HHS'
health evaluation assistance loan program can bar defaulters from
participating in the Medicare program.
Department
of Veterans Affairs. To collect on defaults in the DVA
housing loan programs, some loans are paid through allotment of
DVA benefit checks, which may not be paid to private loan holders.
In addition, DVA offers beneficial financing not available in
the private sector to help it dispose of Federal property, and
DVA has invested in loss mitigation staff dedicated to pursuing
loan reinstatements and alternatives to foreclosure.
Department
of Defense. Most outstanding Foreign Military Financing
loans are to countries with which official U.S. diplomatic relations
are particularly important and sensitive. This argues against
selling these loans, particularly in cases such as Israel, where
military sales are an important component of the relationship.
In addition, because of the sensitive military nature of FMF loans,
the private sector is likely to be much less willing to acquire
such loans.
USDA Foreign
Agricultural Service. The primary aim of the Public Law
480 program is to provide humanitarian food assistance through
low-interest, long term (30+ year) loans. Borrowers typically
have low credit ratings. Given the high default risk, lack of
collateral, and deep interest subsidies, it is unlikely that private
investors would be interested in purchasing P.L. 480 loan assets.
U.S. Agency
for International Development (USAID). USAID's Economic
Assistance Loans (EAL) and Housing Guarantees (HG) are unlikely
to be of greater value to the private sector. EALs are: (1) sovereign
and primarily in very low-income developing countries; (2) highly
concessional; and (3) long term (30-40 year maturities). Because
the private sector does not have the leverage of the Brooke Amendment
sanctions, diplomatic pressure, or significant foreign aid funds,
nor the ability to use its experience in operating in developed
financial markets in most EAL countries, it is unlikely to have
efficiency gains in collecting on these loans. HG guarantees are
primarily sovereign loans and are similar to EALs, except that
they have market interest rates. Therefore, for the reasons discussed
above, they are unlikely to be attractive to the private sector.
Overseas Private
Investment Corporation (OPIC). Partly through its agreements
with the Governments of the countries in which it does business,
OPIC has historically had low credit losses. In addition, each
guarantee contract carries the full faith and credit of the U.S.
Government. Given the relatively low expected cost to the Government
of these guarantees, and the relatively high price that the beneficiaries
are likely to ask in order to give up the security of the guarantee,
it is unlikely that such buy outs could be undertaken at a savings
to the Government. Because the full faith and credit contractual
issue discussed above does not apply to direct loans, it might
be more feasible to sell outstanding loans to the private sector.
However, direct 16ans tend to be smaller, more risky transactions,
and therefore are not likely to be attractive to the private sector.
Eximbank.
The majority of Eximbank's outstanding portfolio (about 75 percent)
consists of sovereign credits, which are very unlikely to be attractive
to the private actor because of memories in the private sector
of the international debt crisis and the possibility of rescheduling
of sovereign credits. Similarly, while Eximbank's "traditional"
non-sovereign credits are not subject to Paris Club rescheduling,
they are still concentrated 'm riskier developing countries, and
are therefore subject to the same perception of risk in the private
sector.
Next
Steps
In the coming months,
OMB will work with credit agencies and Treasury to form a task
force to evaluate loan portfolio management. The goal of the task
force will be to review options for improving the quality and
efficiency of current practices. Options will include: achieving
efficency gains through upgrading financial systems; increasing
the staff of servicing and liquidation offices; contracting to
the private sector; requiring guaranteed lenders to work out the
loans they originate; and loan asset sales. In considering opportunities
for loan asset sales, the task force will refine the framework
outlined in this chapter. Similar to the credit performance measures
framework discussed in Chapter 8, this framework will be used
to develop decision criteria which can be applied to all loan
portfolios in order to identify programs that show potential for
loan asset sales.
1
Consistent with guidance on modifications in OMB Circular No. A-34,
Section 65.3, the average years remaining to maturity will determine
the appropriate discount rate for net present value calculations
of Governmental cash flows.