[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.