[DOCID: f:1997_per.spec21.wais]

[Analytical Perspectives, Budget of the United States Government,

Fiscal Year 1997]

[Page 285-292]

From the Budget of the U.S., FY 1997 Online via GPO Access


[[Page 285]]



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, non-recourse 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. [CAB note: these were the "old" sales in '87-'88, before; credit reform and before Hamilton]

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


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

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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 transaction 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


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

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flow to the private sector, where the discount factor is 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.

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


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.

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.

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


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's, 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.[CAB note: what Hamilton did was give investors better information so that they realized that (2) and (3) were higher than the would otherwise have realized and actually reduced (4) through improved marketing/digital access]

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.

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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

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have expected default rates of less than one percent, leaving little room for

the private sector to improve on 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


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


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

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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 and 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 all 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


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


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,

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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 be 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 efficency 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 loans 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,

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which are very unlikely to be

attractive to the private sector 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 in 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 portential for loan asset sales.