I. -- United States General Accounting Office Report to the Chairman, Subcommittee ’ 1 GAO on Rural Development and Rural Electrification, Committee on Agriculture, Nutrition, and Forestry, U.S. Senate April II990 LOAN ASSET SALES An Evaluation of FknHA’s 1987 Sales 141338 GAO/AF‘MD-90-42 unitedstates G&O General Accounting Office Washington, D.C. 20548 Accounting and Financial Management Division B-236161 April 6,1996 The Honorable Howell Heflin Chairman, Subcommittee on Rural Development and Rural Electrification Committee on Agriculture, Nutrition, and Forestry United States Senate Dear Mr. Chairman: In your letter of June 27,1988, you asked us to conduct a review of two pilot loan asset sales completed by the Department of Agriculture’s Farmers Home Administration (F~HA). These sales were authorized by the Omnibus Budget Reconciliation Act of 1986, Public Law 99-509, which directed FTIIHAto sell enough loans in fiscal year 1987 from its Rural Housing Insurance Fund and its Rural Development Insurance Fund to realize not less than $2.7 billion in net sale proceeds. To meet these targets, FmHAsold loans with an aggregate unpaid principal bal- ance of more than $4.9 billion and realized over $2.8 billion in net sale proceeds. The responsibility for servicing these loans was also trans- ferred to the loan purchaser, as authorized by the act. This report focuses on whether F~HA (1) conducted these loan asset sales in a professional manner-that is in a manner similar to that of private sector organizations, (2) received the maximum net proceeds practicable for the loan assets sold, and (3) protected the rights of the borrowers whose loans were sold, This report also discusses two commonly held misunderstandings regarding loan asset sales. First, that the net proceeds from F~HA loan asset sales are not as large as those from recourse sales. Second, that the sale of FTMA loans will reduce the budget deficit in both the short and long term. We concluded that F~HA conducted its pilot loan asset sales in a profes- Redults in Brief sional manner by competitively obtaining the services of some of the leading US. investment bankers as financial advisors and underwriters to assist in managing the sales. Further, we found that the ~HA loan sale financing structures followed those established by private sector ” financial markets and used by financial institutions to conduct similar sales for major private sector entities. Overall, the F~HA pilot sales Page 1 GAO/AFMD-90-42 FmHA’e 1987 Loan Asaet Sales adhered to OMB’S loan sale guidelines. In short, the private sector finan- cial markets treated FmHA the same way they would handle any other private sector entity seeking to sell pools of loans. The financing structures and marketing strategies used by financial advisors and underwriters handling the sales, along with FMA’S use of credit enhancements were designed to ensure maximum net sales pro- ceeds. However, the government paid upfront transaction fees of about 3 percent of the amount realized. Our review also showed that the legal rights of the FM borrowers were protected in the loan sale agreements and that the loan servicing rights of the community program borrowers were honored by the commercial loan servicer during the first year following the sale. , The Farmers Home Administration (FmHA), an agency with the Depart- Bdckground on Loan ment of Agriculture, is one of the nation’s leading lenders of rural devel- Abet Sales opment and housing loans. WHA makes direct loans to farmers and rural communities who are unable to obtain credit from commercial lenders at a reasonable rate through its Rural Housing Insurance Fund and Rural Development Insurance Fund.’ In fiscal year 1986, the Reagan administration proposed the pilot sale of federal loan assets as a part of an overall program to improve federal credit management. The chief objectives of these pilot sales were to improve federal loan origination and documentation, reduce the cost of federal credit programs by transferring loan servicing to the private sec- tor, and increase budget receipts in the year of sale. A loan asset sale program was included in the Omnibus Budget and Reconciliation Act of 1986 which directed the Secretary of Agriculture to sell enough loans from the Rural Housing Insurance Fund and the Rural Development Insurance Fund to realize not less than $2.7 billion in net proceeds by the end of fiscal year 1987, $1.7 billion and $1 billion respectively, and which authorized the Secretary to transfer loan servicing responsibility to the loan purchaser. Prior to the sale, F~HA’Sunpaid principal balance due on loans outstanding from these two funds was $29.3 billion and $8.0 billion, respectively. ‘The loans from these funds are more commonly referred to as rural housing loans and community program loans, respectively. Page 2 GAO/AFMD-99-42 FmHA’s 1987 Loan Asset Sales b , B2%!5161 In September 1987, the Secretary of Agriculture sold to private inves- tors rural housing and community program loans with an aggregate unpaid principal balance of $4.9 billion. F~HA transferred loan servicing for the community program loans to a private servicer in September 1987. However, because of its complex rural housing loan servicing pro- cedures, F~HA agreed to continue to service these loans for a maximum period of 2 years following the sale. Servicing of these loans was trans- ferred to the private sector loan servicer in August 1989. Our work focused on determining whether FMA Obj&tives, Scope,and Methodology I l conducted the sales in a professional manner, l received the maximum net proceeds practicable for the value of the loan ! assets sold, and l protected the rights of the rural communities and homeowners during the sale of their loans and after servicing had been transferred to the private sector, Our review was performed primarily at FmHA, which conducted the sales with the assistance of several private sector financial institutions, We also held discussions with the private sector financial advisors and sale underwriters that assisted MA. To determine whether Frnm conducted the pilot sales in a professional manner, we compared FmHA financing/sale structures to those generally used by the secondary credit markets to sell pools of loans offered for sale by private sector entities. We focused on assuring ourselves that the FWIA loan sales were handled by MA’S financial advisors and under- writers in the same manner in which they handled similar sales by the private sector. To determine whether FIXMAreceived the maximum net sale proceeds practicable, we analyzed the F~HA financing structures and marketing strategies used by its financial advisors and underwriters participating in the sale, and we analyzed the costs incurred by F~HA in conducting these sales. In addition, we reviewed the loan sale documentation files available at MA and the proposals received from the other financial institutions interested in helping FhHA conduct the sales, and we inter- viewed agency officials responsible for conducting the sales. Page 3 GAO/AJ?MD-O-42 FmHA’s 1987 Loan Asset Sales I B236161 - Finally, to determine whether the rights of F~HA borrowers were fully protected under these sales, we sent questionnaires to a random sample of 380 of the 3,897 community program borrowers whose loan(s) were sold in September 1987 and still were being serviced by the private ser- vicer at the time of our review. Our sample provided for a 96 percent level of confidence, with a maximum sampling error of plus or minus 6 percent. Rural housing program borrowers were not included in our questionnaire universe because servicing of these loans had not trans- ferred to the private servicer at the time the questionnaires were mailed. FmHA agreed to continue servicing these loans for 2 years after the date of sale. Appendix I contains a copy of the questionnaire and provides summary information on selected responses received. Our audit was performed between August 1988 and November 1989, in accordance with generally accepted government auditing standards. As requested by your office, we did not obtain official agency comments on this report. We did, however, discuss the matters in this report with MIA officials during the course of our review and have incorporated their views where appropriate. FmHA conducted the sale of its rural housing and community program FhHA Conducted loans in a professional manner. We defined “professional manner,” as Loan Sales in a those sale structures and approaches used by the private sector finan- Professional Manner cial institutions to sell similar securities for private sector entities. In addition, the fees charged F~HA by its sale underwriters were compar- able to fees charged to other private entities conducting similar sales. F~HA competitively obtained the management services of private sector financial institutions to serve as financial advisors and loan sale under- writers for its loan sales. These financial institutions assisted F~HA in conducting the pilot sales in a manner similar to that used when they conduct securitized asset sales for major private sector entities. The FIIIHA sales were conducted using a structured sales approach and credit enhancements to secure an AAA rating for the financial interest sold. The AAA rating is the highest credit rating granted to private sector securities and, consequently, would help to ensure the marketability of the securities. For both the rural housing and community program loan sales, F~HA competitively selected a sales management team drawn from major U.S. Page 4 GAO/AFMD-99-42 FinHA’s 1987 Loan Asset Sales E235161 financial institutions to assist in managing the loan sales.2 These man- agement teams were composed of a financial advisor and a group of seven to eight underwriters. They assisted F~HA in structuring the sale and provided professional advice and consultation to FIIIHA during the entire sales process. F~HA competitively selected the investment firms of Kidder, Peabody and Company, and Manufacturers Hanover Trust Company to serve as financial advisors for its rural housing and community program loan sales, respectively. In addition, F~HA competitively selected a group of technically qualified underwriters to participate in each loan sale. Each underwriting group was headed by a lead underwriter. Shearson Lehman Brothers, Inc. was selected as the lead underwriter for the community program loan sale and Salomon Brothers, Inc. for the rural housing sale. These underwriting groups negotiated the placement of the financial interests in the loan pools with private investors-a practice which is common for securitized asset sales with the financial magnitude of m’s loan asset sales. The securitized loan sale structures recommended and used by RIJHA’S sale management teams were similar to those structures used in the securitized sale of corporate assets and by the Federal National Mort- gage Association to conduct similar mortgage backed security sales. For example, F~HA’Ssales management team formed a special purpose pri- vate corporation to take title to the community program loans and to issue bonds to private investors as financial interests in the loan pools. Similarly, the FmHA loan sales management team for the rural housing loans formed a rural housing trust which issued mortgaged backed securities similar to those used by the Federal National Mortgage Associ- ation that represented equity interests in the loans held by the trust. Appendix III provides more detailed information on the loan sale financ- ing structures used by FIWA and the types of trusts created. In keeping with generally accepted financing practices within the existing secondary credit markets,3 MA’S rural housing and community program loan sales involved the pooling of loans and the sale of securi- ties-financial interests in the pooled loans-to private investors. These 2Appendi II contains a detailed listing of the major financial institutions participating on these msn- agement teams. 3The secondary credit markets serve as a medium through which the financial community trade mortgage and nonmortgage loans and related securities. Page 5 GAO/AF’MD-9042 FmHA’s 1987 Loan Asset Sales B-235161 - sales include the features described below and are commonly termed structured sales, as opposed to the simple auction of individual loans like the sale of Treasury securities. Further, the F’IIIHA sales were classi- fied as structured sales because the sales structure generally included 9 creating a new security, such as a bond or participation certificate, using the future principal and interest payments from the pooled loans as collateral; l arranging for a third-party commercial organization to collect and account for loan principal and interest payments from borrowers-that is, servicing the pooled loans; and . providing some form of credit enhancement for the new security-that is, compensating purchasers at the time of sale for estimated future loan losses. The foregoing structured sales techniques, including credit enhance- ments, are those currently being used in the private sector financial market to provide private sector entities, state and local government agencies, as well as FmHA, with the means of selling pools of loans to maximize net sale proceeds. The rural housing and community program loan sales used two forms of credit enhancements-overcollateralization and credit insurance. These credit enhancements were used to ensure that the bonds and mortgaged backed securities sold to private investors received a AAA credit rat- ing-the highest credit rating given securities in the private sector mar- kets.4 The AAA credit rating was desired to help ensure that FIIIHA received the maximum net sale proceeds practicable from the sale. By overcollateralization, we mean that FIWA transferred to the trusts a pool of loans whose aggregate unpaid principal balance was greater than the face value of the securities sold. The overcollateralization amount is determined by the rating agencies-Standard and Poors and Moody’s Investors Service- and is based on the collateral quality which considers such things as the historic loan collection, delinquency, and loss rates. Credit insurance obtained from an independent private insurance com- pany guarantees all or a portion of the investor’s income stream 40MB’s loan asset sale guidelines precluded loan sales with future recourse to the government; that is, sales with some type of government guarantee protecting the purchaser against future loan losses. OMB’s guidelines did permit, however, purchasers to provide credit enhancements such as overcol- lateralization and credit insurance. Page 6 GAO/AFMD-9942 FhHA’s 1987 Loan Asset Sales , B-236161 expected from the receipt of future principal and interest payments due on the securities sold. F’mHA used credit insurance to complement the overcollateralization on the rural housing sale to form a total credit enhancement package that would ensure a AAA credit rating for the financial securities sold to private investors. This policy guarantees the holders of senior financial interests in the trust 100 percent of their scheduled principal and interest payments in the event the trust is unable to make these payments. Credit insurance was not used on the community program sale because the sale received a AAA rating based solely on the degree of overcollateralization provided by MA. These forms of credit enhancements are common practice in the private sector financial markets. For example, these forms of credit enhance- ments are used by private sector entities for the securitized sale of pooled automobile loans. As a matter of fact, many private corporations guarantee the payment of principal and interest on some securitized sales. Co& of FrnHA Pilot Saks Thti Cost of Conducting Loan asset sales under the pilot program were conducted on a credit Credit Enhanced Sales Is enhanced basis. OMB’S loan sale guidelines prohibit any federal guaran- tee of principal and interest payments or repurchase agreement-future Reflected in Net Sale recourse-which the government has used in past sales. However, agen- Proceeds cies were permitted to conduct loan sales on a credit enhanced” basis using the credit enhancements discussed in the previous section. These enhancements provide prospective investors limited protection against future losses. The net proceeds realized from the FYIIHA sales, an average of 58 percent of the unpaid principal balance of the loans sold, primarily reflect the up-front costs associated with credit enhanced sales. These costs include the interest rate discount amount” given investors who “Credit enhanced sales, as defined for the purpose of this report, do not include those sales which provide a federal guarantee or repurchase agreement. The financial community does consider these types of recourse provisions to be credit enhancements. “The interest rate discount amount is the reduction in sale proceeds that results when the coupon rate of the financial interests sold is lower than the interest rate of comparable securities at the time of sale. Page 7 GAO/AFMD-9042 FmHA’s 1987 LOan Asset Sales B-236161 I purchased financial interests in the rural housing and community pro- gram trusts as well as the cost of credit enhancements required by the rating agencies to obtain the highest credit rating for the financial inter- ests sold. These net proceeds also reflect about $91 million in sales transaction costs, or about 3 percent of net sale proceeds, paid by F~HA at the time of sale. Ne: Proceeds The FMA net sale proceeds are equal to or above those realized by other federal agencies consummating loan sales under the pilot program on a credit enhanced basis. MA conducted its pilot sale in accordance with OMB’Sloan asset guidelines and employed generally accepted financing I structures to maximize its sale proceeds from these pilot sales. Nothing I came to our attention during the course of this review to indicate that I I F&IA could have restructured these sales to allow it to substantially I I increase the net sale proceeds realized from these sales. FmHArealized over $2.8 billion in total net proceeds from the securitized sale of its rural housing and community program loans with an aggre- gate unpaid principal of over $4.9 billion. This amount exceeded the rev- enue target of $2.7 billion set in the Omnibus Budget Reconciliation Act of 1986 by $106 million. These net proceeds represent about 58 percent of the total aggregate unpaid principal balance of the loans sold. The remainder of the government’s unpaid principal balance went essen- tially towards three types of costs incurred by FYCIHA in conducting these sales. These costs include interest rate discounts, credit enhancements, and sales transaction costs. Table 1 shows the net proceeds realized from both F~HA sales and the related expenses of the sale. Page I3 GAO/AFMD-90-42 FmHA’s 1987 LOan Asset Sales Table ): Analysis of Proceeds From FmHPLILoan Asset Sales Dollars in millions / Community Rural I prw;~g hou3i Total Unpaid principal balance of loans sold $1,934.4 $2,969.0 $4,903.4 Face value of financial interests not sold 0 c594.OP 1594.01 Face value of financial interests sold 1,934.4 2,575.O 4.309.4 Interest rate discounts (614.0) (313.2) (927.2) Present value of financial interests sold 1,320.4 2,061.8 3,382.2 Cost of credit enhancements on financial interests sold (186.3) (282.6)b (468.9) Gross sale proceeds 1,134.l. 1j79.2’ 2I913.3. Transaction costs (56.9) (34.5) 191.41 Net sale proceeds $1,077.2 $1,744.7 $2,821.9 aFmHA holds subordinate securities in the rural housing trust for this amount. bThis includes $61.5 million for the cost of credit insurance used in the rural housing sale. As shown in table 1, a significant factor in determining the govern- ment’s net sale proceeds was the interest rate discounts which repre- sents $927 million or 19 percent of the unpaid principal balance. These discounts were necessary to compensate investors for the difference in the interest rate on the securities offered by FIIIHAand the market inter- est rate available to investors at the time the loans were sold. For exam- ple, the IMHA community program trust securities were offered to investors at a coupon rate of 4.6 percent in a market environment where 30-year Treasury obligations were yielding 9 to 10 percent. As a result, these financial interests had to be discounted to compensate investors for this disparity in interest rates, The 4.6 percent rate was close to the level charged to borrowers under the &HA program. Another factor that impacted F~HA’Snet sale proceeds was the cost of credit enhancements-overcollateralization and credit insurance. The credit enhancements for both sales totalled $468.9 million. Overcollater- alization on the community program sale resulted in a reduction of $186.3 million in sale proceeds, while the rural housing sale proceeds were reduced by $282.6 million due to overcollateralization and insur- ance costs. As mentioned above, these costs were necessary to obtain the highest quality rating for the financial interests sold, which helped to maximize net sale proceeds. The amount of overcollateralization provided by FI~IHAwas the amount required by the security rating agencies to compensate investors if Page 9 GAO/AFMD-90-42 FbHA’s 1987 Loan Asset Sales B.235161 actual loan losses exceed anticipated losses at the time the sale was con- summated. If actual losses are less than anticipated, the government will receive back any unused overcollateralization and other remaining inter- est in the trust when the trust is terminated-that is, when all obliga- tions of the trust have been paid. This amount is called the government’s residual interest7 At the time of sale, the estimated value of FMW’S residual interest in these trusts was valued at over $234.6 million- $33.6 million in the community program trust and $201 million in the rural housing trust. The latter amount includes $180 million which rep- resents the fair market value, at date of sale, of the $694 million in subordinate securities held by F~HA in the rural housing trust. The $234.6 million represents the estimated value of additional cash flows F’mHA should receive from the two loan sales we reviewed. The remainder of the government’s unpaid principal balance, $91 mil- lion or 2 percent, represents the fee FYnHA paid for conducting these credit enhanced sales. This amount represents costs that the govern- ment would not have incurred if it had held the loans to maturity. Table 2 provides a breakout of these various transaction costs. Tablei2: FmHA Sales Transactlon Coats Dollars in millions Community Rural program housing sale sale Total Financial advisors fees $1 .o $1.1 $2.1 Underwriting fees 15.3 17.9 33.2 Issuance costs 5.5 5.5 11.0 Reserve/special accountsa 35.1 10.0 45.1 Total $56.9 $34.5 $91.4 aThese accounts include reserve funds for such trust expenses as principal and interest payments, loan servicing fees, and estimated future income tax liabilities. Yields From FmHA Sales The net sale proceeds realized from F~HA’Ssale of its rural housing and FalJ Within Range of Other community program loans fall within the range of that obtained from other federal agencies conducting credit enhanced sales under the pilot Credit Enhanced Sales program. As previously mentioned, F~HA’Snet sale proceeds to-date on 7Residual interest is the estimated equity value of all excess funds remaining in the trust after all Y trust obligations have been satisfied. This amount is comprised of such things as excess overcollater- aliiation and servicing fees, and excess interest earned on reserve funds. These pilot sales were among the first government loan asset sales to use overcollaterahzation and commercial credit insur- ance as credit enhancement techniques. In the past, government sales have generally been consum- mated on a full recourse basis. Page 10 GAO/AFMD-90-42 FmHA’s 1987 Loan Asset Sales ‘C ! . R-286161 these pilot sales have averaged 58 percent of the government’s unpaid principal balance. These amounts are similar to the results achieved by other federal agencies which consummated pilot sales during the same time frames and under similar market conditions. For example, the net sale proceeds realized by other federal agencies selling financial inter- ests through a similar type financing structure, using overcollateraliza- tion and insurance as credit enhancements, ranged between 64 and 66 percent of the aggregate unpaid principal balances of the sold loans, as shown in the following table. Table 3: Comparison of FmHA Sale Procec/ds to Other Credit Enhanced Dollars in millions sale8 j Unpaid Net principal sales Percent Federal loan sales sold proceeds realized I FmHA loan sales Community program $1,927 $1,078 56 Rural housing 2,969 1,746 59 Department of Commerce 28 15 54 Department of Education 761 412 54 Department of Veterans Affairs 309 172 56 Total $5,994 $3,423 As these sales were among the first sales to be conducted under OMB’S loan sale guidelines, no precedent existed for conducting these sales or for determining what would be a reasonable rate of net sale proceeds. While these net proceeds may not be comparable because of the differ- ences in the quality of the loans and interest rate of the underlying loan pools, they do provide one measure of the success or failure of the FMIA sales. The above comparison shows that the yields on the FMIA sales were equal to or above those obtained through other pilot sales. FmHAtook steps to protect the legal rights of the rural housing and com- Rights of FmHA munity program borrowers whose loans were sold in the 1987 pilot sales Boirrowers Were Fully in the sale agreements. Specifically, the agreements between FmHA and Pr&ected During Sale the trusts included provisions to continue all the significant rights avail- able to these borrowers under FMM regulations. Further, our study of a sample of F~HA community programs borrowers confirmed that the orig- inal legal provisions of these loans had not changed and that they had ” ‘Rural Housing program borrowers were not included in our sample because FmHA was servicing these loans at the time of our review. Page 11 GAO/AFMD-QO-42 FmHA’s 1987 Loan Awet Saks B235161 not been adversely affected by the sale. Several borrowers did, however, voice concern over certain additional accounting and financial reporting requirements which were placed upon them by the new loan servicer and which F~HA had not previously exercised. As FXIHAproceeded with the sale of its community program and rural housing loans, one of its primary objectives was to fully protect borrow- ers’ rights. Registration statements filed with the Securities and Exchange Commission and the legal documents associated with these sales all stipulate that the notes and bonds would not be altered, thus protecting all the borrowers’ legal rights. Specifically, these documents provide for the protection of such rights as the following: Loan reamortization-that is, the extension of a loan’s repayment period to the maximum. Loan assumption-that is, the transfer of loan repayment responsibility from one borrower to another. Payment moratorium- that is, the deferral of principal and interest payments for a qualified borrower in whole or in part for a period of 2 years. . Interest credit-that is, the subsidy of the interest payments for quali- fied borrowers. A sample of 380 community program borrowers, whose loans are now being serviced by the General Electric Capital Corporation, confirmed that these borrowers’ legal and loan servicing rights had been protected during the first year following the sale. For instance, when asked what impact the new private servicer has had on loan servicing, 82 percent of the 3 11 respondents stated that no change had been made with regard to the original provisions of their loans. Further, we found that only five borrowers, or 2 percent of the respondents, had requested any type of special servicing from the new servicer involving rights previously available under ~HA servicing procedures. These borrowers sought the private servicer’s approval to sell or lease assets used to secure the loan. Approval was granted in three of the five cases. Further, the majority of the community program borrowers, about 80 percent, rated the overall performance of the new servicer as being adequate or better. However, over 16 percent of the respondents did express concern over the additional accounting and reporting requirements placed upon them by the new loan servicer, but these complaints primarily involved Page 12 GAO/AFMLS90-42 FmHA’e 1987 Loan Asset Sales reporting requirements which FMLA was not enforcing. For example, these borrowers complained about requests for increases in insurance coverage and for annual audited financial statements. According to M officials, the private servicer is within its legal rights to request this information. Specifically, to protect the government’s interest, F~HA regulations require borrowers to show proof of insurance each year and also authorized F~HA to require borrowers to provide annual financial audits. F~HA officials stated that F~HA has been lax in enforcing these regulations in the past and that corrective actions were under way to ensure that these regulations would be enforced in the future. The concept of selling federal loan assets to private investors is not new. ProceedsFrom Credit Historically, FXIHA has sold securities-participation certificates-to the Enhanced SalesAre public which were backed by a specific pool of loans. The net proceeds Noti Comparable to reported from these recourse sales have averaged over 99 percent of the aggregate unpaid principal balance in the loans sold. The FTMAloan RetiourseSales asset sales discussed in this report, however, were not conducted on the same basis as prior sales of federal loan assets and the difference in sale basis resulted in the FmHA sales yielding an average of 58 percent. Con- sequently, the reported net sale results from these sales are not compar- able because the recourse net sale proceeds do not reflect the interest I rate discount, recourse costs, and sale costs actually incurred by the , government in conducting these sales. These costs are paid separately by the government over the life of the trust and are not reflected in net sale proceeds. In the two pilot sales discussed in this report, F~HA incurred interest rate discounts, credit enhancements (which are analo- gous to recourse costs), and sale costs. These costs were paid in total at the date of sale and were explicitly disclosed as a deduction from sale proceeds. Consequently, the 99 and 58 percent net sale proceed percent- ages should not be compared because they are computed on different bases. The interest rate discount paid by F~HA to compensate investors for the difference between the coupon rate of the financial interests sold and the market interest rate was not reflected in the recourse sales because in those sales, F~HA subsidized the coupon rate offered on the securities. F~HA paid the holders of these recourse securities the difference between the interest due on the securities sold and the interest collected from the pooled loans because the interest rate of the underlying collat- eral loans was less than the coupon rate promised on the financial inter- ests sold. As a result, the securities in these recourse sales were not significantly discounted at the time of sale because F~HA subsidized the Page 13 GAO/AFMD-90-42 FmHA’s 1987 Loan Asset Saks - coupon rate of these securities, offering them at an interest rate compar- able to the market interest rate of similar securities. F~HA paid this dif- ference-the interest credit subsidy-over the life of the securities sold from its appropriated funds and did not deduct it from the net sale pro- ceeds reported at the time of sale. These net proceeds also do not reflect losses experienced by FMIA as a result of loan defaults, delinquencies, and/or prepayments to the pooled loans. This cost is paid up front in a credit enhanced sale and is limited to the amount of overcollateralization and credit insurance paid at the time of sale. In past recourse sales, losses due to loan defaults, delin- quencies, and prepayments were borne solely by IWHA over the life of the financial interests sold and were not shared with private investors. Lastly, the proceeds from recourse sales do not reflect all the transac- tion costs which occur in credit enhanced sales. Specifically, F~HA incurred no financial advisor fees or trust operating expenses in these recourse sales. In addition, the underwriting commissions for the recourse sales were passed on to the investor and not paid by the federal government. A misunderstanding regarding loan sales is the view held by the current S&e of FmHA Loans and past administrations that loan sales are a means of reducing the Will Not Reduce budget deficit. As we have stated in previous reports and testimonies, Federal Deficit and as our current analysis indicates, loan sales will not reduce the structural budget deficit. Such sales simply shift the present value of loan principal and interest payments, which the federal government expected to receive in future years, to the year of sale. Consequently, budget cash receipts are increased in the year of sale-thereby reducing the budget deficit for that year. However, in the future years that span the payback periods of the sold loans, budgetary cash receipts are simi- larly reduced. For the two F~HA loan sales we reviewed, financial interests with a face value of $4.3 billion were sold to investors. These securities, which were backed by FIMA loans, had an estimated present value of $3.4 billion because, at the time the securities were sold, market interest rates were higher than the interest rates carried by the loans. The market value of these securities was further adjusted downward by $.5 billion to pay for ‘An Assessment of the Government’s Loan Asset Sale Program (GAO/T-AFMD-87-7, March 26, 1987) and Loan Asset Sales: An Assessment of Selected Saks (GAO/AFMD-88-24, February 19, 1988). Page 14 GAO/AFMD-9642 FmHA’s 1987 Loan Asset Sake ’ B-235161 credit enhancements-overcollateralization and credit insurance- required to protect investors against future loan losses. The resulting $2.9 billion represents, on a present value basis, the net loan principal and interest payments F~HA would have expected to receive if it had held the loans to term rather than sold them. Thus, MA gave up receiv- ing $2.9 billion. In conducting the loan sales, FYI-IHA was charged about $.I billion in sale costs which were deducted to yield net sale proceeds of $2.8 billion to FmHA in the year of sale. Consequently, government budgetary receipts were increased in the year of sale by $2.8 billion and the government could avoid $2.8 billion in borrowing to meet its cash needs. In the bud- getary years following the sale, the government will have to borrow $2.9 billion (in present value terms), in addition to other borrowing to meet cash needs, because it gave up the right to receive these funds. Consequently, over the long term, the structural budget deficit is not reduced because of loan asset sales. The F~HA loan sales were conducted in a professional manner in an Obbervations effort to maximize the sale proceeds to the government. The government incurred about $91 million in sales transaction costs that it would not otherwise have incurred had it held the loans to maturity. The reduction in net sale proceeds caused by the interest rate discounts given investors and the costs of credit enhancements represent unavoidable costs F~HA incurred in conducting these credit enhanced sales. The rights of the borrowers whose loans were sold were fully protected during the loan sale transactions. The sale of federal loans .is not a sound approach to reducing this coun- try’s structural deficit. Such sales simply accelerate the government’s rights to receive future revenues to the year of sale. The transaction costs associated with these sales are the price the government pays for accelerating these cash receipts. If the net proceeds from these sales equal the government’s present value in the loans less anticipated loan defaults and delinquencies, the government incurs neither a gain nor loss. If the net sale proceeds are less than the government’s present value, then the government incurs a loss, as in the FKIHA sales. Further, since these sales do not create additional future cash receipts above those which the government would have received if it had held the loans, the projected future annual deficit will increase because revenues anticipated from loan payments will decrease in later years. Page 15 GAO/AFMD-99-42 F’mHA’s 1987 Loam Asset sales I B-236161 As agreed with your office, we did not obtain agency comments. Unless you publicly announce the contents of this report earlier, we will not distribute it until 30 days from the date of this report. At that time we will send copies of the report to the, Director of the Office of Manage- ment and Budget, the Secretary of Agriculture, and other interested par- ties. We will also make copies available to others upon request. Please contact me at (202) 275-9454 if you or your staff have any ques- tions regarding the contents of this report. Major contributors to this report are listed in appendix IV. Sincerely yours, w Jeffrey C. Steinhoff Director, Financial Management Systems and Audit Oversight Page 16 GAO/~9642 FmHA’s 1987 Loan Asset sales Page 17 GAO/AFlKJ.b99-42 FmHA’s 1987 Loan Asset Sales v‘tter 1 A$pendix I 20 Survey to Evaluate Servicing of unity Program Afipendix II 27 List of Major Pwticipants in the Rhral Housing and COmmunity Program L&an Sales Appendix III 28 SelectedInformation OIJthe Rural Housing a@dCommunity Pfogram Financing Structures Appendix IV 30 Major Contributors to This Report Related GAO Products 32 Tkbles Table 1: Analysis of Proceeds From FmHA Loan Asset Sales Table 2: FmHA Sales Transaction Costs 10 Table 3: Comparison of FmHA Sale Proceeds to Other 11 Credit Enhanced Sales Page 18 GAO/AFMD-9042 FmHA’s 1987 Loan Asset Sales Abbreviations FmHA Farmers Home Administration OMB Office of Management and Budget Page 19 GAO/AFMLMM42 FmHA’s 1987 Loan Asset Sake Apbndix I , SQrveyto Evaluate Servicingof Commtiw fiogramLoans - -I- Survey to Evaluate Servicing of Community Program Loans INSTRUCTIONS The respondentto this swey shouldprovideanswersto eachapplicablequestionand,if necessary,seek thehelp The UnitedStatesGeneralAccountingOffice (GAO)is of co-wotkemor associates in answerhrgthesequestions. anindependentcongressional agencywhich assiststhe lf GECCis sewicingmorethanoneof your Congressin overseeingtheoperationof thefederal organixation’sloans.baseyour organization’sanswerson government.Recently,the Congte.saskedusto review all loansto which the questionapplies.For overall the Departmentof Agriculture’ssaleof community satisfactionquestions,baseyour organixation’sanswer programloansto privateinvestors.The purposeof this on its combinedexperiencewith all loans. surveyis to determinehow well theseprivatecompanies areservicingcommunityprogramloanslike yours. Whatyour organizationhasto sayasa community programborroweris importantto this study. Your name ln September1987,the Secretaryof Agriculturesold or organizationwiU not be identifiedin our report; all about6,000communityprogramloansto private responseswill bekeptconfidential.Remember,we investors.As a result,the responsibiityfor servicing cannotmakeanaccurateevaluationof this areawithout theseloanstransferredfromthe FarmersHome your assistanceandparticipation, Administration(FmHA)to the GeneralElectricCapital Corporation(GECC),formerlytheGeneralElectric Pleasereturnyour completedquestionnairein the CreditCorporation. self-addressed envelopewithin 15days. The return addressis: Throughthis survey,we areaskingfor informationon your organization’sservicingexperienceswith GECC. US. General Accounting Offlce By servicingwemeanbiing, collections,andhandling Mr. Ernst Stockel, AFMD of anyotherloan-Matedactivities. Wewantto knowthe Room 6OB7 effect,if any,the changefrom a governmentagencyto a 441 G Street, NW privatecompanyhashadon your organization. Washtngton, DC 20548 Wewouldhaveliked to talk to ah thoseaffectedby this If you haveanyquestions,pleasecontactRonald Parker sale,but thatwouldhavebeentoo time-consumingand at (202) 634-5217 or Ernst Stockel at (202) 695.7111. costly.Therefore,we tooka randomsampleof about380 borrowersto representa cmsssectionof all the RESPONDENTINPORh%ATION(PleasePrint) communityprogtamborrowers.Sinceour sampleis (Primarypersoncompletingthe survey) small,it is importantthateveryborrowerselected answersour survey questions. Name: This surveyshouldtakeno longerthan30 minutesto Title: complete.It shouldbecompletedby the staffmemberin your organizationwhois mostknowledgeable about Monthsin position: Phone#: GECC’sservicingof your account. Pleasecormctanyermmin the following information: * Page 20 GAO/AF’MD-90-42 FmHA’s 1987 Loan Asset Sales . Appendix I Survey to Evaluate Servidng of C~nununi~ ProgralnLoan6 1. Hasthe GeneralElect& CapitalCorporadon 5. Sincethe Mdal transferof your ~~UXJZ& hasGECC (GECC)servicedyour organization’saccountsince madeanyof thefollowing change8in the provisions October1987(i.e.,bllllng, collection,andother of anyOfyour loans?(Check all that apply) loan-relatedactivities)?(Checkone) m-31) W3) I.0 Increasedpaymentamount 4 1.0 Yes (CONTlNUB) 311 i. 0 Changedfinal paymentduedate 0 2. 0 No (STOP - Return quedionnalre in 9 self-addressed envelope) 3. 0 DecreaseU daysallowedbeforelate feeis o charlled 4.0 lncnasedlatepaymentfee 1 2. Whenwereyou first notifkd thattheFarmersHome AdministrationCFmHA)would no longerbe 5.0 Other, specify 25 servicingyour organization’saccount?(Fill In the bkmkl 6. 0 No provisionsfor anyloan havechanged 255 7. 0 No basisto judge 10 No answer 16 If anyof the aboveitems( tl through#S) 3. Whonotified your organizationof this change? havebeenchecked,pleaseexplain: (Check all that apply) (Pm I.0 FmHA 262 2.0 GECC 95 3.0 Other,specify: 6 4. 0 No basisto judge 13 No Anewer 4 4. Wasyour organizationgivenenoughnoticebefore you hadto makeyour first scheduledpaymentto GECC?(Check one) cw 1.0 Yes 282 2.0 No (EXPLAIN BELOW) 18 3. 0 No basisto judge 10 NO answer 1 If no, explain: Page 21 GAO/AFMLMW42 FmHA’s 1987 Loan Asset Sales Appendix I Survey to Evahate Servidngof Commudy : ProgralnLoane 6. HasGECCaddedanyunusualexpenses to your 8. Forhow manyof your organization’sloansdid you organization’saccountwithout prior notice askfor the following setvices?(Please spec@the (excludinglatepaymentfees)?(Checkone) number of loans for each service requested in WI Question 7) 1.0 Yes (EXPLAINBELOW) 23 2.0 No 280 3. 0 No bardstojudge 8 If yes,explain: Service requested from QECC 1. Reamotdzeanyloan (rearrange anyof the original terms) 2. Approvethe saleor exchangeof allorapartoftheassets 4 securlrl~anyloan ! 1 3. Approvetheleaseof all or a part 1 of thepropertysecuringanyloan I I 7. Sincethetransferof your account,hasyour 4. Subordiite its hen securingany organizationasked GECCto performanyof the loan (placepaymentof another following services?(Check all that apply) debtaheadof GECCin eventof (3330) default) 1. 0 Reamortizeanyloan(rearrangeanyof the 5. Approvethetransferof original terms) 0 responsibiityfor anyloan to a 2. 0 Approvethe saleor exchangeof all or a part third party I I of the assetssecuringanyloan 4 Not applicable 306 3. 0 Approvetheleaseof ah or apartof the propertysecuringanyloan 1 4. 0 Subordinateits lien securinganyloan(place paymentof anotherdebtaheadof GECCin eventof default) 0 9. Did GECCapproveall of the servicesyou askedfor 5. 0 Approvethe transferof responsibiityfor any in Question71 (Check one) loanto a third party (@I 0 1. 0 Yes (GOTO QUBSTlON13) 3 6. 0 Noneof the aboveserviceshavebeen 2.0 No 2 requested 294 (GOTO QUESTlON13) 3. 0 No basisto judge(GOTO QUESTION13) 7. 0 No basisto judge 6 Not applicable 306 (GOTO QUESTION13) No answer 6 Page 22 GAO/AFMD-90-42 FmHA’s 1987 Loan Asset sales 10. For how manyof your organlzation’rloansdid GECCdenythe serviceyou askedfofl (Please specify the number of loansfor each servicr detded by GECC) OMOl I 2. Approvethe saleor exchangeof 1 I 1 5. Approvethe transferof responsibilityfor anyloan to a third party Not applicable 309 No answer 1 11. Did GECCadequatelyexplainall the denials specified in Questionlo? (Check one) WI 1. q Yes(GOTO QUESTION13) 2.0 No 3. 0 No basisto judge(GOTO QuEsTION 13) Not applicable 310 No anewer 1 Page 23 GAO/AFMDSO& F&IA’s 1981 ban Amet &lea Appendix I Survey to Evaluate Servlclng of Community FrogramL4mns 12. For eachdeniedqucat for services,pleaseindicate:(1) the servicedenied,(2) GECC’smson for denial,(3) why youbellevethemaon wasinadequate,and(4) whateffect.if any,thedenialhadon your organization. z(l=m Page 24 GAO/AFMD-99-42 FmHA’s 1987 Loan Asset Sales Appendix I Survey to Evaluate Servklng of community ProgriunLoanE 13. Hasyour omanizadon asked GECC to wrfonn anv 15. OveralL how would you me GECC’s servicing of othei servic& not mentionedin this quktionnairei your account? (Check one) (Check one) Pa 0 1. q Veryxkquate 97 1. c] Yes(EXPLAIN BELOW) 25 2. cl Generallyadequate 132 2.0 No (GOT0 QUESTION15) 284 3.C1Marginallyadcquate 33 3. 0 No basisto judge(GOTO QUESTION15) 0 4.0 CfetIe~yinadtquatC 16 No answer 2 If yes,approximatelyhow manyrequestshave 5.0 Very inadequate 10 you made? 6.0 No basis to judge 13 No answer 10 If yea,explainthe natureof your quests: 14. Overall,how satisfiedwereyou with GECC’s handlingof the otherservicesmentionedin Question 13?(Check one) WI 1. 0 Satisfiedall of the time 4 2. 0 Satisfiedmostof thetime 9 3. Cl Satisfiedhalf of the time 2 4. 0 Dissatisfiedmostof thetime 3 5. 0 DissatisfiedalI of the time 7 6. 0 No basisto judge 2 Not applicable 284 Page 25 GAO/AFMD-99-42 FmHA’s 1987 Loan Asset Sales Appendix I Survey to Evaluate Servic@ oiCommu&y Rorpam- 16. Overall, how would you rate the quality of service you am receiving from CMCC aa compued to that p~~vkhd by FmHA?(Check one) ml 1.0 OECC substantially bc@x than FmHA 6 2. c] GECCmoderatelybetterthanFmHA 12 3. q GECCaboutthesameasFmHA 176 4. c] GECCmoderatelyworsethanFmHA 54 5. c] GECCsubstantiallyworsethanFmHA 2 5 6. c] No basisto judge 29 No anawer 9 Pleaseexplainyour response: 17. If you haveanyadditionalcomments,pleaseexpressyour viewsbelowandon theblankcover page& if necessary. Thank you for your assistance. n (Mar. 1989, AFMD, JFL) Page 26 GAO/AFlMD-00.42 FmHA’s 1987 Loan Aaaet S&a Lisk of Major Participants in the Rural Housing an@community Program Loan Sales I ~~ -I-- Rur+l Housing Program Finahcial Advisor Kidder, Peabody, & Co. Lead1Underwriter Salomon Brothers, Inc. E. F. Hutton & Co., Inc. Shearson Lehman Brothers, Inc. Goldman, Sachs & Co. I Co-Managing Underwriters TheFirstBostonCOW. Merrill Lynch Capital Markets Bear, Stearns & Co., Inc. Manufacturers Hanover Ltd. Master Servicer Manufacturers Hanover Agent Bank Services Corp. Cordunity Program Financial Advisor Manufacturers Hanover Trust Co, Lead Underwriter Shearson Lehman Brothers, Inc. Co-Lead Underwriters Salomon Brothers, Inc. Morgan Stanley, & Co. Co-@IanagingUnderwriters ($)~~~;e~;o~y~~;o , , Bear, Stearns & Co., Inc. Merrill Lynch Capital Markets Y Master Servicer General Electric Capital Corp. Page 27 GAO/~90.42 FmlU’s 1987Loan Asset Saiee Apbndix I III v 23@xtedIdormation on the Rural Housing and Qxmunity Program l?lnancingStructures R$ral Housing Ptogram N me of Issuing Entity Rural Housing Trust 1987- 1 B T$pe of Trust Real Estate Mortgage Investment Conduit (REMIC)’ ~~ T#pe of Security Issued - Pass-through certificate2 I P$r Value of Securities $2,376 billion S#ld Classesof Securities Issued clansA (Senior)--80 percent Class B (Subordinate)-20 percent Ck.editRating of Securities z:z; t-Nzated - Credit Enhancements Used Overcollateralization-80/20 ratio3 Credit Insurance-$61.6 million-cost of insurance policy with Ameri- can Loan Guarantee Association ‘A REMIC is a special purpose non-taxable entity authorized by the Tax Reform Act of 1986 which holds a fixed pool of real estate mortgages and which issues securities to its investors representing their financial interest in the pool of mortgages. ‘A pass-through certificate is a debt instrument which is secured by a pool of loans. The issuer of Y these securities passes principal and interest payments made on the loan pool to investors on a regu- lar basis, These certificates, also known as participation certificates, are often issued by quasi- governmental agencies such as the Federal National Mortgage Association. 3Ratio of senior/subordinate securities. Page 22 GAO/Al?MD-9942 FmHA’s 1987 Loan Asset Sales * Seleetad Information on the Rural Housing and Cbmmunity Program Financingstructures Com@mity Program Namd of Issuing Entity Community Program Loan Trust 198’7 A I Type lof Trust Business Trust4 1 Type of Security Issued CM0 type bond” I Par ‘itialueof Securities $1.934 billion Sold ’ Classesof Securities Issued cl~ * (Senior)--93 percent Class B (Subordinate)-7 percent Credit Rating of Securities EfE; i-ATnus - Overcollateralization-93/7 ratio6 Credit Enhancements Used Credi. insurmce not used 4A business trust is a trust which is taxable as a corporation and wherein legal title to its business ass&s are vested with the trustees who hold and manage them for the benefit of trust beneficiaries. “A collateralized mortgage obligation(CM0) is a type of mortgage-backed corporate bond which has a multiclass(multitranche) priority structure. In such issues, each class of bonds is ranked in order by which it can be redeemed. “Ratio of senior/subordinate securities Page 29 GAO/AFMD-O-42 FmHA’s 1987 Loan Asset sales A&pendix I IV fj4qjorContributors to This Report Ernst F. Stockel, Assistant Director, Financial Management Systems and Accounting and Audit Oversight, (202) 697-0816 Financial Management Ronald E. Parker, Accountant-in-Charge Qivision, Washington Denise Ho, Accountant Christina L. Quattrociocchi, Accountant James F. Loschiavo, Evaluator Gary L. Kepplinger, Associate General Counsel Office of the General Alan N. Belkin, Senior Attorney Counsel Page 30 GAO/AFMDBO-42 FmHA’s 1937 Loan Asset Salem L Page 31 GAO/AFMD-B&42 FmHA’s 1987 Loan Asset Sales RelatedGAO lhducts Borrower Loan Prepayments: OMBGuidelines Need to be Strengthened (GAOIAFMD-89-19,January 11, 1989). Federal Assets: Information on Completed and Proposed Sales (GAO/ September 2 1,1988). RCED-&I&214FS, Budget Reform for the Federal Government (GAO/T-AFMD-88-13, June 7, 1988). Loan Asset Sales: An Assessment of Selected Sales (GAO/AFMD-88-24,Feb- ruary 19,1988). An Assessment of the Government’s Loan Asset Sales Program (GAO/T- AFMD87-7,March 26, 1987). The Government’s Loan Asset Sales Pilot Program (GAO/T-AFMD-~~-~, March 10, 1987). The Government’s Loan Asset Sales Pilot Program, statement of Charles A. Bowsher, Comptroller General, before the Legislation and National Security Subcommittee, House Committee on Government Operations (September 26,1986). Loan Asset Sales: OMBPolicies Will Result in Program Objectives Not Being Fully Achieved (GAO/AFMD-86-79,September 26, 1986). (901478) Page 32 GAO/~BO-42 FmHA’s 1987 Loan Asset Salea Ordt*rs must, Iw l9rt~l9aid by c;lsh or by clwck or money order nude oiii I.0 1 tit& Srll9t~ririt,errdt~I~t, ol’ Ih9~iimt~nt.s. .- IJnited States First-Class Mail Genwal Accounting Office Postage & Fees Paid VVa.shington, D.t:. 20548 GAO Permit No. GlOO Official Business Penalty for Private Ilse $300
Loan Asset Sales: An Evaluation of FmHA's 1987 Sales
Published by the Government Accountability Office on 1990-04-06.
Below is a raw (and likely hideous) rendition of the original report. (PDF)