Export-Import Bank:

OMB's Method for Estimating Bank's Loss Rates Involves Challenges and Lacks Transparency

GAO-04-531: Published: Sep 30, 2004. Publicly Released: Sep 30, 2004.

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The Export-Import Bank (Ex-Im Bank) facilitates U.S. exports by extending credit to foreign governments and corporations, mostly in developing countries. The Federal Credit Reform Act requires Ex-Im Bank to estimate its net future losses, called "subsidy costs," for budget purposes. Beginning with fiscal year 2003, the Office of Management and Budget (OMB) significantly changed its methodology for estimating a key subsidy cost component: the expected loss rates across a range of risk ratings of U.S.-provided international credits. In response to a congressional mandate, GAO agreed to (1) describe OMB's current and former methodologies and the rationale for the recent revisions, (2) determine the current methodology's impact on Ex-Im Bank, and (3) assess the methodology and how it was developed.

OMB changed its method for determining expected loss rates for U.S. international credits, with one basis being that emerging finance literature indicated the former approach might overstate losses to the government. While it formerly used only interest rate differences across bonds to derive expected loss rates, it now uses corporate bond default data, adjusted for trends in interest rates, to predict defaults and makes assumptions regarding recoveries to estimate expected loss rates. As the figure shows, expected loss rates fell under the new approach: they were higher across risk rating categories in fiscal year 2002 (the last year that the former method was used) than in fiscal year 2005. This drop has contributed to lower Ex-Im Bank projections of subsidy costs and budget needs. OMB's current method for estimating expected loss rates involves challenges and lacks transparency. Estimating such losses on developing country financing is inherently difficult, and OMB's shift to using corporate default data has some basis, given the practices of some other financial institutions and limitations in other data sources. However, the corporate default data's coverage of developing countries has historically been limited, and their predictive value for Ex-Im Bank losses is not yet established. OMB's method generally predicts lower defaults than the corporate default data it used, whereas more recent corporate data show higher default rates. At the same time, OMB has assumed increasingly lower recovery rates, which serve to somewhat offset the lower default expectations, but the basis for the recovery rates and the changes over time has not been transparent. In addition, despite the method's complexity, OMB developed it independently and provided affected agencies with limited information about its basis or structure.

Status Legend:

More Info
  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendations for Executive Action

    Recommendation: To improve the transparency of the subsidy cost estimation process and help ensure the validity of estimates over time, the Director of the Office of Management and Budget should request from Ex-Im Bank and other U.S. international lending agencies the most complete and reliable data on their default and repayment histories and periodically obtain updated information, so that the validity of the data on which the current methodology is based can be assessed as sufficient agency data are available.

    Agency Affected: Executive Office of the President: Office of Management and Budget

    Status: Closed - Implemented

    Comments: OMB has ongoing access to Ex-Im data, according to OMB and Ex-Im officials. OMB has reviewed that data in order to approve Ex-Im's shift, effective for the 2008 budget year, to using its own historical default and recovery data--and not OMB loss rates to estimate budgetary costs under credit reform. According to OMB, it also continues to work with other U.S. international lending agencies on improving their data collection. OMB stated, however, that since the other agencies' historical data is not currently as broad, useful, or complete as Ex-Im data, OMB does not expect its work with the other agencies on their historical data to yield similar improvements. Thus, the extent to which OMB can use default data from other agencies to revise its loss rate methodologies is limited at this time.

    Recommendation: To improve the transparency of the subsidy cost estimation process and help ensure the validity of estimates over time, the Director of the Office of Management and Budget should ensure that data from nonagency sources--for example, rating agencies' corporate default data, which are used to estimate expected loss rates--be updated as appropriate.

    Agency Affected: Executive Office of the President: Office of Management and Budget

    Status: Closed - Implemented

    Comments: OMB officials have confirmed that OMB updated the corporate default data used in the loss estimation model. At the time of our report, the model used published corporate default data from 1920-1989. OMB stated that it updated the model to use default data covering the period 1920-2006. In addition, GAO subsequently analyzed Moody's corporate default data through 2007, and determined that the default rates through 2007 were not significantly different from those through 2006. Therefore, the single update OMB made appears to be reasonable over this time period.

    Recommendation: To improve the transparency of the subsidy cost estimation process and help ensure the validity of estimates over time, the Director of the Office of Management and Budget should provide similar information in the event of significant changes in its method of calculating expected loss rates.

    Agency Affected: Executive Office of the President: Office of Management and Budget

    Status: Closed - Implemented

    Comments: OMB officials confirmed that no significant changes to OMB's loss estimation model have occurred since 2004; therefore, additional technical descriptions have not been needed. [Note, that in response to GAO recommendation 1 in the same report, OMB indicated that it had provided affected U.S. government agencies with a technical description of the expected loss model.] Thus, this recommendation can be closed as implemented.

    Recommendation: To improve the transparency of the subsidy cost estimation process and help ensure the validity of estimates over time, the Director of the Office of Management and Budget should provide Interagency Country Risk Assessment System agencies and Congress a technical description of OMB's expected loss methodology, including the default model, the key assumptions OMB made, and the data it used.

    Agency Affected: Executive Office of the President: Office of Management and Budget

    Status: Closed - Implemented

    Comments: OMB officials confirmed that OMB completed technical documentation of the loss estimation model in August 2006. They stated that the documentation was sent to the relevant agencies and includes the default model and key assumptions made. According to OMB, it will provide this information to Congress upon request, but Congress has not yet requested such information.

    Recommendation: To improve the transparency of the subsidy cost estimation process and help ensure the validity of estimates over time, the Director of the Office of Management and Budget should arrange for independent methodological review of OMB's expected loss rate model and assumptions and document that review.

    Agency Affected: Executive Office of the President: Office of Management and Budget

    Status: Closed - Not Implemented

    Comments: As of July 14, 2008, OMB indicated that "OMB continues to plan on seeking comments from a range of academics and finance professionals outside of government on the method as appropriate." Thus, because OMB has not yet demonstrated specific steps taken toward this end, this recommendation should at this time be closed as not implemented.

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