Session 2: Considerations in Program and Product Design
Session 3: Valuation and Subsidy Measures
Session 4: Credit Portfolio Costs and Managing Performance
Sessions
This introductory session provides an opportunity for participants to consider, more broadly, government involvement in the credit marketplace. Discussion centers on market failures that commonly lead to the creation of government credit programs and ways to identify and quantify mission objectives and program outcomes for the purpose of ensuring policy effectiveness.
Overview
- Example of a misalignment of program objectives and outcomes
- Participants provide answers to pre-class assignments: Mission objectives and outcomes for their agencies (discussion)
- Instructors pose key justification questions based on participant examples (discussion)
- The notion of a “Return on Subsidy”
- The risks of reporting more relevant objectives and outcomes
- Balancing taxpayer risk and policy goals
Mission
- What drives the creation or expansion of a federal credit program?
- The successful and the not-so-successful: examples from six federal agencies
- Setting program objectives
- Measuring/reporting program outcomes
Metrics
- Data-driven decisionmaking: aligning objectives with outcomes
- For the economy
- For the specific consumer or commercial borrowing sector
- For the credit and lending sector
- For defining the credit product niche
- Developing a plan to measure broader economic and societal impact
Interactive
- Quantifying Mission. Discussion aimed at converting agency mission and programs into metrics that matter for demonstrating value and/or need for change
- Using Metrics. Discussion focuses on using metrics in planning, budget development and execution.
Lecture Slides
Session 1 Slides: Introduction and Program Objectives (PDF)
Charts
Chart 1.1: Defining the Mission, the Market, Mission Success, and Agency Performance
Chart 1.2: How do we Know We’ve Suceeded?
Chart 1.3: How do we Minimize Risk and Costs While Maximizing Impact?
Chart 1.4: The Problem That Needs to be Solved
Chart 1.5: Examples of Products Created in Response
Chart 1.6: Map from TRF
Chart 1.7: The Relationship Between Objectives and Outcomes
Chart 1.8: Macro Indicators
Chart 1.9: Agency Specific (SBA Example)
Chart 1.10: Examples of Different Kinds of Lenders
Chart 1.11: Commercial Banks with Assets Greater than $3 Billion (EOY)
Chart 1.12: Metrics that Define the Asset
Chart Files: Charts for Session 1 (XLSX); Charts for Session 1 (PDF)
Providing financial aid or support with the aim of promoting economic and social policy entails subsidization, and that general concept is introduced in this session. Some missions require a larger federal footprint while others might benefit from more private involvement. There are five basic platform options for delivering intended subsidies and they are designed to be responsive to the distinction. Delivery platforms should be evaluated and compared in terms of structure, taxpayer risk and cost, magnitude of obligation, difficulty of management, need for partnership, level of control, extent of mission impact and other attributes – including whether the proposed credit product is suitable to the beneficiary. A range of decisions is associated with product design including: amount, rate, term, amortization, credit risk and demography. Finally, this session focuses on the functioning of the combined product and platform over time and considers metric adjustments to ensure the portfolio reflects market conditions. GCFP provides a proprietary calculator that incorporates the product design, delivery platform and program performance assumptions into a single set of forecasts for both the agency and its lending partners or grantees. Objective is to ensure delivery platform and product design minimize taxpayer risk/cost and maximize prospects for mission accomplishment.
Subsidy
Notion of subsidy since the very nature of government provision of credit entails some form of subsidization, regardless of expected costs
- High-level discussion of various economic and financial concepts that can be considered in measuring subsidy
- Identifying the financial benefits of the subsidization, and showing how and to whom they are distributed through the deal structure
Delivery Platform
- Metrics that define the nature, size and location of credit needs
- Natural partners for each of the platforms: private lenders and service providers, state and local agencies and organizations
- Continuum of options for delivering subsidies: e.g., grants, direct loans, credit guarantees, insurance, credit enhancements, tax credits
Elements of Product Design
- Metrics-based decisions to ensure suitability of product to targeted needs and policy objectives
- Rudimentary forecasts of annual activity for the agency
- Identifying program operating and credit loss expenses for the agency
- The complete program forecast: the agency, participating lender or grantee
- Adjusting program for changes in market conditions; potential for program evolution or even eventual sunset
Interactive
- Identifying a credit gap of national importance and the metrics used to demonstrate program effectiveness in addressing.
- Best credit product. Problem: Develop the best product to fit a gap within a given subsidy and administrative budget.
Lecture Slides
Session 2 Slides: Considerations in Program and Product Design (PDF)
Charts
Chart 2.1: How do we Minimize Risk and Costs While Maximizing Impact?
Chart 2.2: Calculation of the Benefits EX-IM Bank
Chart 2.3: Calculation of the Benfits of the SBA 7a
Chart 2.4: Calculation of the Benefits of the CDFI Fund NMTC
Chart 2.5: Why is There a Credit Gap?
Chart 2.6: Examples of Different Kinds of Lenders
Chart 2.7: “Quick and Dirty” Unit Cost Analysis
Chart 2.8: Product Delivery
Chart 2.9: Platform Type
Chart 2.10: Leveraging the Platform
Chart 2.11: BUT - Downside Risk
Chart 2.12 Downside Risk
Chart Files: Charts for Session 2 (XLSX); Charts for Session 2 (PDF)
Determining whether a particular government credit program is in the public interest requires a careful assessment of costs and benefits. A primary focus is the credit subsidy. This session aims to educate participants on the basic finance principles used to assess and forecast this cost. For illustrative purposes, the discussion will be based around an example of how each facet shows up in the planning process of one agency.
Key Lessons from MIT Finance Courses: Principles of Corporate Finance
Calculating costs and value
- Investments have equity holders: risk and return, market discount rates
- Cash flows, discount rates and net present values
- Various constructs for measuring costs
FCRA and the budget
- FCRA-mandated Treasury discount rates
- Calculation of credit subsidies and re-estimates
Practical applications
- Impact on platform and product design; example of economics and risks of credit guarantees relative to the other platforms
- How programs actually perform and a way to compare results across agencies
Interactive
- Discussion of raising/ lowering the subsidy to influence use and redefine targeted populations.
- Asset sale and valuation considerations. Should we sell? Can we sell?
Lecture Slides
Session 3 Slides: Valuation and Subsidy Measures (PDF)
Charts
Charts for this session are not currently available.
Extending credit involves more than getting money out the door in a timely manner. There are widely used techniques and tools for managing credit portfolios efficiently and prudently, and also for measuring program effectiveness. In this session, focus is on the the information necessary for managing performance including the functions associated with extending credit, the costs, the range of choices in performing the functions and the benchmarking of performance. The session is not about Information Technology, but rather how to think about the dynamics of credit-related activities. From the standpoint of the agency budget, such activities are generally funded out of the administrative budget. Session also includes an overview of methods for identifying, assessing and managing credit risk. Finally, this session addresses the metrics that can be used to identify program impact and effectiveness. Together such metrics provide a general basis for performing program cost-benefit analysis.
Operating Cost
There are seven basic functions in the extension of credit: Marketing, origination, underwriting, closing, servicing, monitoring and exit. This session explores:
- Importance and costs of each function Unit cost analysis
- The benefits delegating, outsourcing or sharing the functions
- Technological advances Reducing operating costs through limiting volume and asset sales
Credit Losses
In order to assess risk in a portfolio, program manager relies on a well-defined set of definitions, risk assessment tools and reporting protocols.
- What sort of credit risk are we taking?
- Key problem: the loss curve
- The weak links in the lending process
- Credit scoring
- Definitions: delinquency, modificaton, default, recovery and other key categories
- Rating the loans and reserving percentages
- The concept of the credit audit
Performance Measurement and Evaluation
Key metrics in portfolio management:
- Internal performance measures
- External performance measurement: comparative analysis with the private sector
Interactive
- How many credit functions do we wish to keep in-house and what is the cost-benefit?
- Going from a flawed private sector solution to a federal direct lending solution. The trade-off between operating costs (and practices) and mission objectives coupled with the difficulty of defining delinquency and default.
Lecture Slides
Session 4 Slides: Managing Operating Costs and Credit Risk (PDF)
Charts
Chart 4.1: The Seven Basic Functions for Extending Credit
Chart 4.2: Claculating Operating Costs by Function
Chart 4.3: The Unit Cost Analysis
Chart 4.4: Delegating, Outsourcing, and Sharing
Chart 4.5: Lowering Costs Through Techology Upgrades
Chart 4.6: What Kind of Risk Are we Supposed to be Preparing For?
Chart 4.7: Key Problem: The Loss Curve
Chart 4.8: Credit Scoring
Chart 4.9: Standard Definitions
Chart 4.10: Examples of Rating a Loan and Allocating Losses
Chart 4.11: Credit Audit
Chart 4.12: Key Operating Data Points
Chart 4.13: Key Credit Risk Data Points
Chart 4.14: Conversion Application for Comparative Analysis: From Credit Reform Calculations to Standard Institutional Reporting
Chart Files: Charts for Session 4 (XLSX); Charts for Session 4 (PDF)
This session explores how for-profit institutions approach the provision of credit. The purpose is to gain insights into their operations to enable government partnering agencies to better interface and protect taxpayer dollars in various public-private partnerships that can form to extend credit to borrowers.
Benefits and Risks
- Adverse selection, lack of transparency, regulatory capture, conflicts of interest
- Credit portfolio management objectives for large loan, small loan and non-profit portfolios
- Accounting for delinquencies, charge-offs, and loss reserves: what it does and does not tell us
- How they game the system
- Metrics for detecting the games
Predicting Credit Risk at For-Profit Lending Partners
- Who are they?
- What are they doing? Trend line analysis
- What are they thinking? The key driver and key strategy
- A successful agency solution: SBA’s PARRIS
Predicting Credit Risk at Non-Profit Partners
- The key differences
- A successful agency solution: the NeighborWorks PROMPT
Remediation
- Protecting the program from excessive risk and misuse
- Segmentation by performance in key metrics
- Graduated remedies
Interactive
- Based on metrics of three different small business lenders going into 2007, which of them will have the worst performing loans and which will survive—two different outcomes?
- Remediation: Suppose a recipient of grant money from HUD for multifamily housing development is not using funds properly.
Lecture Slides
Session 5 Slides: Working with Private Partners (PDF)
Charts
Chart 5.1: Anticipating and Accounting for Credit Losses
Chart 5.2: T-accounts for the Loss Reserve
Chart 5.3: Examples of Different Kinds of Lenders
Chart 5.4: Commercial Banks with Assets Greater than $3 Billion (EOY)
Chart 5.5: The Chief Focus and Related Strategies
Chart 5.6: A Successful Agency Solution: The SBA’s Parris System for Participating Lenders
Chart 5.7: The Neighborworks Prompt for Non-profit Development Corporations and CDFIS
Chart 5.8: Risk Indicators for a Small Non-depository Program Participant (Broker, Mortgage Banker, Asset-based Lender)
Chart 5.9: Agency Protocols and Procedures for Participating Lenders with Different Risk Ratings
Chart 5.10: Graduated Remedies for Participating Lenders with Poor Ratings
Chart 5.11: Quick Track of the Portfolio Trend and the Outliers
Chart Files: Charts for Session 5 (XLSX); Charts for Session 5 (PDF)
In this session participants break into groups to explore the creation of various hypothetical federal credit programs. Groups will consider mission and metrics including program design (e.g., market failure / rationale, objectives, structure), funding (e.g., taxpayer risk, subsidy BA, operating expenses), management (e.g., operate, monitor, measure impact, adjust) and sunset.
Case 1: Health Care Mortgages
Policymakers are exploring the creation of a federal credit program to help people afford transformative therapies that cure potentially lethal conditions such as cancer or hepatitis C. Breakthrough hepatitis C drugs such as Sovaldi and Harvoni can cure people of the liver-destroying disease in a few months, but the price tag of $84,000 or more has led many insurers to limit coverage to people whose disease has significantly progressed to show signs of liver damage. In order to make such treatments more widely available, the government is considering the establishment of a program to increase the availability of funds for such drugs but would require that individuals who are cured would repay amounts provided, over time.
Case 2: Climate Change Adaptation
In anticipation of climate change (e.g., rising sea levels, erratic and severe weather patterns), policymakers are considering the creation of a loan program to help citizens and businesses relocate from high-risk areas that are particularly vulnerable to flooding or other adverse impacts from global warming. Staff have been asked to design a loan program to enable affordable relocation while keeping taxpayer costs at a minimum.
Case 3: Municipal Infrastructure Assistance
Given severe physical infrastructure needs across the US, policymakers are considering ways the federal government might support municipal governments to spur national infrastructure development and improvement. By providing bond insurance or support, costs to municipalities would fall, thereby increasing likelihood of such projects being funded. All options are being considered: Grants, loans, bond guaranties, credit enhancements and tax incentives—although the loan and loan guaranty options seem to have some initial support given expectations of low cost estimates.
Case 4: Community Development Lending by State Governments
Policymakers are exploring the creation of a program to allow state government to “rent” its full faith and credit designation to spur community development lending in distressed parts of the country. Unlike the federal government, state governments are generally prohibited by law from pledging their credit on behalf of private parties. Instead, state loan and loan guarantee programs are backed by dedicated reserve accounts. A new program would have the federal government play some role (e.g., capital provider, lender, guarantor) to stimulate the creation of state-level funds to fund small business creation / growth and other economic development projects.
Case 5: Eye Bonds
Congress is considering legislation to establish an “Eye Bond” program to spur research and investment in the treatment and cure of ocular diseases. The initial program would focus on one category of disease and build within it a diversified portfolio of eligible projects just short of treating patients. Once the concept of attracting new, long term institutional investment funding for biomedical research, other treatments could be considered for funding in a similar fashion. Bond proceed would go to small labs, university researchers and other scientists struggling to take basic research to patients. The National Eye Institute, part of NIH, will select eligible projects. Government risk is initially limited to no more than $1 billion of bonds with no more than $250 million issued in any one year of five authorized for the program. The USG guarantee can apply to no more than 50% of the principal amount of bonds issued and cannot cover any of the interest payments. Bonds must be structured to give first priority to protecting the interests of taxpayers and all cash received from eye bond repayments must first be used to reduce the amount of USG guarantees. No guarantee shall be made unless an appropriation has been provided or the bond issuer makes a payment to the government for the full cost of the guarantee.
Case 6: Zero-emissions Auto Manufacturers Assistance Program
Policymakers are considering the establishment of a program to reduce funding costs for companies involved in the manufacture of zero-emission automobiles. A range of options is being considered where the federal government would play some role (e.g., capital provider, lender, bond or loan guarantor) to stimulate additional development and commercialization of green-car technologies.
Course Info
Instructors
Departments
As Taught In
Summer
2016
