Session 3 December 13, 8:30-9:30am. Managing Federal Credit Programs

Transcription

1 Session 3 December 13, 8:30-9:30am Managing Federal Credit Programs 1

2 Assessing comparative advantage for credit extension functions Critical decisions: Which functions to perform in-house? When to use a private partner? These choices have first-order impact on administrative costs, loan performance, borrower satisfaction, goal attainment, etc. Apply principle of comparative advantage: who is best positioned to perform the task most efficiently and effectively? 2

3 Assessing comparative advantage for credit extension functions Marketing Origination Servicing Funding Always more expensive for private partners Historical reason agency borrowing centralized in Treasury was to gain from liquidity advantage Adding a layer of intermediation adds risks. Investors demand compensation for those risks (e.g., performance risk on FHA mortgages) Screening and monitoring Risk bearing Resolving defaults 3

4 Assessing comparative advantage for credit extension functions Marketing Origination Servicing Funding Screening and monitoring Can benefit from greater flexibility and profit incentives in the private sector But these mechanisms will only work if program structure and rules allow them to Risk bearing E.g., failure of guaranteed student loans to assign meaningful responsibility Resolving defaults 4

5 Assessing comparative advantage for credit extension functions Marketing Origination Servicing Funding Screening and monitoring Risk bearing Putting private partners in a first loss or risk-sharing position creates incentives for diligence in screening and monitoring Government has advantage at absorbing and spreading catastrophic or tail risks Can be expensive to compensate private sector to bear tail risk But advantage in risk transfer is to have market measure of price of the risk Resolving defaults Example of Freddie Mac STACR securities 5

6 Credit risk transfer to private sector on many new Freddie Mac 30-year mortgages 6

7 Assessing comparative advantage for components of credit extension Marketing Origination Servicing Funding Screening and monitoring Risk bearing Resolving defaults Can benefit from greater flexibility and incentive structures with private partners But can make it harder to maintain control, e.g., over workouts and borrower interactions Critical to maintain competition in market for service providers to avoid rent capture 7

8 Implications for guaranteed lending Puts most or all credit functions in private hands When is guaranteed lending more or less efficient? Can be better when monitoring and screening are important, and when lenders have skin-in-the-game and latitude to act Can be more costly for gov t and borrowers when fees are set by regulation rather than by market forces Can be more costly when guarantee benefits are captured by lenders, e.g., when market structure is insufficiently competitive Guaranteed lenders generally have a funding cost disadvantage; efficiencies have to be large enough to outweigh costs Reason to provide securitization platforms as with mortgages, SBA, HECMs 8

9 Guaranteed lending in practice Some examples: HECM Reverse Mortgage program Little lender latitude, no risk bearing, little competition, rents to lenders (Lucas, 2015) Now-discontinued Guaranteed Student Loan program No latitude, very little risk bearing, competition for rents did not lower costs for students, rents to lenders and schools (Lucas and Moore, 2010) Small Business Administration s 7a program Value added from private screening and monitoring, good use of risksharing, but limited competition and rents to lenders (de Andrade and Lucas, 2013) 9

10 What kind of credit risk are we supposed to be preparing for? Overarching issues 10 Points of view that often guide or govern the level of credit risk The banks aren't lending in my District The government ought not to be in the lending business: if borrowers aren't bankable they shouldn't borrow The government is not taking enough risk The government should keep credit losses under 2 % The program should be budget neutral The government should never lend to make a profit The government is here to help me: concessionary rates, modifications, waivers, less paperwork burden The government will (or should) never foreclose on me I have a right to participate in this credit program The government should never take a subordinate position The government should always take a subordinate position Risk-based pricing Usury begins at 9% All Other

11 default rate.001 default rate The Key Problem: The Loss Curve default rate Q year single family mortgages # defaults/# loans default rate Q year single family mortgages # defaults/# loans default rate Q year single family mortgages # defaults/# loans months age in months at default months age in months at default months 4 outliers trimmed for perspective - see above chart age in months at default 11

12 Anticipating and Accounting for Credit Losses Total Loans $100,000,000 Aging Schedule Delinquent Days Delinquent Delinquent Delinquent Modifications Dollar Value $5,000,000 $575,000 $325,000 $750,000 $1,250,000 Percentage to Total Loa 5.00% 0.58% 0.33% 0.75% 1.25% Loss Progression Beginning Loss Reserve Provision for Losses Gross Charge-offs Recoveries Ending Loss Reserve $2,000,000 $600,000 $500,000 $200,000 $2,300, % 0.60% 0.50% 0.20% 2.30% 12

13 Credit Scoring Credit Score Loan Volume Charged-off Loss Rate Number of Loans $665,787,329 $29,315, % 2, $641,832,238 $20,946, % 2, $581,054,849 $10,019, % 1, $428,922,655 $6,197, % 1, $213,636,108 $2,321, % $58,352,984 $194, % 149 TOTAL $25,895,876,163 $68,996, % 8,073 13

14 The SBA s PARRiS System for Depositories and Large Small Business Lenders P - Portfolio Performance 5 year cumulative net yield 12 month default rate 5 year default rate cumulative net cash flow divided by the SBA guaranteed portion default amount over last 12 months divided by the average balance plus the default amount over 12 months default amount over the last 5 years divided by the average balance plus the default amount over 5 years A - Asset Management Stressed Rate Early Problem Loan Rate High Risk Origination Rate Past due days, defferred, plus delinquent (60 days or more) divided by balance Balance for young loans that have been deferred, delinquent, purchased, or liquidated within 18 months of origination Approval amount for young loans (36 mos or <) that are high risk: SBPS credit score of 160 or less divided by Approval amount for young loans R - Regulatory Compliance Loans in default status > 3 years 24 Month Repair/Denial Rate Balance of loans in default status over 3 years divided by all loans in default Last 24 months in repair, denial or purchase divided by SBA purchase amount 1502 Reporting Rate 14 # of reporting loans divided by total loans in lender's portfolio

15 The SBA s PARRiS System for Depositories and Large Small Business Lenders (2) Ri - Risk Management FDIC Total Risk Based Capital Non-Performing Asset Ratio Lender Purchase Rating S - Special Items Average SBPS credit score Recovery Rate last 5 years Overall institution risk and a Lender s use of an effective governance model to identify, understand, and mitigate risk exposure in its 7(a) portfolio. FDIC benchmarks Nonperforming assets plus loans 90 or more days past due to equity and reserves Lender rating based on forecasted puchases for the next 12 months Additional key metrics or items that are not included in the other components but may pose risk to SBA or present program integrity concerns Average small business portfolio score (SBPS) weighted by loan balance Recovery rate (after SBA purchase) for defaulted loans charged off or paid in full over 5 years divided by cumulative default amount for loans charged off or paid in full over last 5 years No Regulator/Regulatory Action The occurrence of a public corrective action or absence of a prudential regulator of In addition: Loan Agent Rate Franchise Concentration Sold on Secondary Market Industry Concentration Acquired Loan Rate Loans > $2mm over last 12 months 15

16 A Key Predictive Indicator MAJOR BANK (OOO'S) Gross revenue including trading income 19,413,461 24,898,307 26,271,461 25,999,230 45,731,923 Net Income after tax 5,213,000 6,399,000 5,706,000 3,636,000 20,696,000 Total loans and leases, net 290,654, ,599, ,678, ,076, ,562,000 Total delinquent loans and leases 4,050,000 5,335,000 7,124,000 13,571,000 26,450,000 Loss Reserve 2,122,000 2,088,000 3,625,000 8,273,000 10,349,000 Dividend Yield for the Year % Non-interest Operating Expense 14,990,000 16,221,000 18,114,000 19,015,000 38,197,000 Provision for Loan and Lease Losses 425, ,000 3,598,000 9,897,000 2,157,000 Net credit losses 736, ,000 2,100,000 5,365,000 2,542,000 High Stock Price Average Stock Price Low Stock Price

17 NeighborWorks PROMPT System for Nonprofit Community Development Corporations Production/Program Service Risks: Attempting services beyond the organization's mission or capacity can lead to wasted resources and lessened cost effectiveness. Services that do not meet partner and funder expectations can lead to dissatisfaction and reduced participation and support. Resource and Financial Management Risks: Unrealistic funding projections, poor strategies and inability to evaluate cash flow requirements can lead to funding deficits. An organization may jeopardize its viability through inadequate accounting systems and procedures and insufficient staffing, reporting and oversight. Organizational Management and Board Governance Risks: Insufficient exercise of management and oversight responsibilities could create unnecessary liabilities for the corporation and its members. Inadequate volunteer participation and orientation, and a lack of cyclical staff evaluations and training can lead to ineffective board, committee and staff functioning and excessive turnover. Management Staffing and Personnel Risks: Inadequate human resource policies and management practices can cause reduced staff effectiveness, excessive turnover. Planning Risks: Poorly defined plans and goals that do not provide clarity to board members and staff may lead to inconsistent services, limited impact, and wasted resources. A lack of cyclical planning can reduce consensus and jeopardize the organization's image, resources and effectiveness. Technical Operating and Compliance Systems Risks: A lack of written and approved operating policies and procedures for each major program service component may impede service delivery. Inadequate client management, service delivery and contract management systems can lead to non-conformance with contracts and loss of funding. Failure to identify 17 legal and contract demands can lead to unexpected liabilities and a loss of credibility and funding.

18 Ex-Im Bank s Strategy for Assessing Small For- Profits: Brokers, Asset-Based Lenders 1. Segmentation of Lender Characteristics (DELEGATED LENDER: THEY UNDERWRITE) Experience Years undewriting product line < to 10 2 > 10 3 Staffing Number of total deals to total staff > to 50 2 < 50 3 Credit Losses Credit losses to total loans > 5% 0 5%-3% 1 < 3% 2 Recoveries Recovery to defaulted principal < 10% 0 10% to 20% 1 > 20% 2 Rate of Growth Number of deals this year vs previous year > 150% % 2 < 120% 3 Deal Size Largest deal to last year's average deal size > 150% % 1 < 120% 2 Deal Flow Number of deals Per Year < to 10 1 > 10 2 Claims Experience Claims due to poor underwriting >120% ofaverage % of Avg 5 < 80% of Avg 10 Totals for Categorizing Non-Depository Small Lenders Monitoring Schedule Total Score < > 13 Standard Review Financial Condition, Portfolio Quality Qrtr Annual Annual Credit Audit Performed by Agency Annual Three Years 0 Field Audit Performed by Agency Adverse Annual Adverse Event Adverse Event 3. Graduated Remedies Steps in order are tied to the scores above Increase Minimum Borrower Credit Score Reduce Borrower Credit Limits Reduce Lender Credit Limits Limit Number of Transactions Charge Lender Higher Fees Cease Delegated Authority Terminate Participation Sue

19 Calculating Operating Costs by Function The information we get that is misleading Operating Expenses $29,081,000 $ Loan Volume this $175,000,000 # Loan Volume this 500 Average Size of Loan $350,000 Number of Loans In 3,000 Loans Outstanding $1,050,000,000 PROBLEM: Cost to $34, % Cos $3, % Bottom-up analysis of what the true cost is Total # of Staff Number of Loans Handled Total Direct FTE Cost FTE Cost per Unit Unit Cost Indirect Staff and Resources Administrative Allocation Loans per Marketing FTE 2 2,000 $250,000 $ % $750,000 $300,000 Loans per Originating FTE 60 1,000 $5,920,000 $5, % $2,250,000 $2,451,000 Loans per Servicing FTE 40 3,000 $3,600,000 $1, % $6,000,000 $2,880,000 Loans per Monitoring FTE 10 3,000 $750,000 $ % $1,200,000 $585,000 Loans per Default Remediation FTE $750,000 $2, % $900,000 $495, ,300 $11,270,000 WHAT??? 2.86% $11,100,000 $6,711,000 Check Benchmarks Check Benchmarks 19

20 Integrating performance & budgeting Monitor performance from budgetary & programmatic POV Assess past performance; take action Adjust budgeted amounts (looking back but, importantly, going forward) and/or risk thresholds Key is to balance policy goals with risks and taxpayer costs Inform policies, practices, underwriting standards & budgeting with performance metrics tied to statutory purpose Develop oversight/control functions sufficiently independent of program management Develop expertise within agency to identify emerging issues using realtime information re outstanding portfolio, including credit & operational risks 20

21 Monitoring loan performance Monitor, diagnose & report Include regular collections, analysis & reporting of information/trends on aggregate and cohort basis Flexible to deliver analysis necessary to identify & respond to developing issues Coordinate closely with budget staff and enable virtuous feedback loop within agency Use dashboards, watch-lists, pipeline reports & other tools to track performance in real-time and to serve as early-warning indicators See Appendix D in A-129 for templates of various dashboards and other reports 21

22 Shared services Shared services gaining traction in other areas Federal financial management (payroll, financial systems) Procurement (strategic sourcing) Information technology (category management) Is there an opportunity for shared services across federal credit community? Subsidy rate estimation Loan servicing Lender monitoring Debt collection Asset disposition 22

23 Interesting to ponder a centralized credit unit Assess budgetary impacts of credit programs Ensure uniformity of approach in planning/evaluation Consider need for loan programs / assist in design Develop analytically rigorous risk management practices Establish automated and consistent underwriting systems Recommend policies aimed at improving program cost efficiency Develop consistent performance measures across credit agencies Design ways to close out programs that become irrelevant or no longer justify public subsidization 23