    [Analytical Perspectives]
    [Other Technical Presentations]
    [21. Loan Asset Valuation]
    [From the U.S. Government Printing Office, www.gpo.gov]

                                  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, 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.
                         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
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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
    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
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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.