United States Government Accountability Office 

GAO Report to Congressional Committees 


September 2004  EXPORT-IMPORT 

BANK 

OMB’s Method for 

Estimating Bank’s 

Loss Rates Involves 

Challenges and Lacks 

Transparency 

a
 
 GAO-04-531 

Highlights of GAO-04-531, a report to 

congressional committees 

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. 

GAO recommends that the Director 

of OMB provide affected U.S. 

agencies and Congress with 

technical descriptions of its current 

expected loss methodology and 

update this information when there 

are changes. GAO also 

recommends that the Director 

arrange for independent review of 

the methodology and ask U.S. 

international credit agencies for 

their most complete, reliable data 

on default and repayment histories, 

so that the validity of the data on 

which the methodology is based 

can be assessed over time. 

www.gao.gov/cgi-bin/getrpt?GAO-04-531. 

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Celia Thomas, 

(202-512-8987), thomasc@gao.gov. 

September 2004 

EXPORT-IMPORT BANK 

OMB's Method for Estimating Bank's 

Loss Rates Involves Challenges and 

Lacks Transparency 

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. 

OMB Expected Loss Rates for U.S. Government International Credits by Risk Rating 

Category (Present Value Basis), Fiscal Years 2002 and 2005 

Percentage expected loss 

40 

30 

20 

10 

0 

FY 2002 FY 2005 

1 2 3 4 5 6 7 8 

low Risk rating category high 

Source: GAO analysis of OMB expected loss rates. 
Contents 


Letter 


Results in Brief 


Background 


OMB Developed New Method That Lowered Expected Loss 


Rates 

Current OMB Methodology Has Lowered Ex-Im Bank’s Projected 

Subsidy Costs and Budgetary Needs 

Loss Estimation Involves Challenges and OMB Methodology Is Not 

Transparent 

Conclusions 

Recommendations for Executive Action 

Agency Comments and Our Evaluation 

1 

3 

6 

11 

22 

30 

39 

40 

40 

Appendixes 

Appendix I: 

Appendix II: 

Appendix III: 

Appendix IV: 

Appendix V: 

Appendix VI: 

Objectives, Scope, and Methodology  42 

Loss Estimation Practices of Foreign Export Credit 


Agencies  49 


ECAs in Canada and the United Kingdom Have Methodologies to 


Estimate Future Defaults and Losses in Determining Reserve 

Levels 49 

ECAs in France and Germany Use Fees to Offset Loss 56 

OECD Participating Countries’ Risk Assessment and Fee 

Arrangement 60 

Loan Loss Allowance Guidance and Select Commercial Bank 

Practices  61 

Loan Loss Allowance Is an Important Factor in an Institution’s 

Financial Condition 61 

Accounting and Regulatory Guidance Are Not Prescriptive; the Loan 

Loss Allowance Requires Significant Judgment 62 

Regulatory Agencies and Accounting Organizations Have Been 

Reviewing Loan Loss Allowance Guidance 68 

Reviewed Banks Follow Basic Concepts in Accounting and 

Regulatory Guidance but Vary in Allowance Methodologies 70 

Interagency Country Risk Assessment System  76 


Credit Reform Budgeting  79 


Technical Description of OMB Model for Estimating 


Expected Loss of U.S. International Credit Activities  82 


Page i  GAO-04-531 Export-Import Bank 
Contents 

Appendix VII:  Comparison of OMB Default Probabilities for Fiscal Years 

2004 and 2005 with Corporate Default Rates Used in OMB 

Model  90 

Appendix VIII:  Trends in Interagency Country Risk Assessment System 

Expected Loss Rates  99 

Appendix IX:  Comments from the Office of Management and Budget  101 

Appendix X:  GAO Contacts and Staff Acknowledgments  103 

GAO Contacts 103 

Staff Acknowledgments 103 

Tables Table 1: Summary of Accounting and Regulatory Guidance 

Followed by Banks in Their Loan Loss Allowance 

Calculation 64 

Table 2: Regulatory Agencies’ Risk Rating Scale 67 

Figures 	 Figure 1: 

Figure 2: 

Figure 3: 

Figure 4: 

Figure 5: 

Figure 6: 

Figure 7: 

Figure 8: 

Figure 9: 

Components of the ICRAS Process 


Trends in Interest Rate Spreads for Argentine, Russian, 


and Mexican Government Bonds as Compared to U.S. 


Treasury Bonds, 1999-2003 


Comparison of OMB Default Probabilities for Fiscal Years 


2004 and 2005 and Moody’s Corporate Default Rates Used 


in OMB Model for Selected Rating Categories 


Comparison of OMB’s Expected Loss Rates, in Present 


Value Terms, for ICRAS Risk Categories 1-8, Fiscal Years 


2002-2005 


Ex-Im Bank Obligation of Budget Authority for New 


Subsidy Costs, Fiscal Years 1992-2003 


Comparison of Ex-Im Bank Exposure Fees and Expected 


Loss Rates by ICRAS Category, Fiscal Years 2002 and 


2005 


Example of a Commercial Bank’s Loan Loss Allowance 


Process for Corporate Loans 


Program and Finance Account Budgeting for Ex-Im Bank 


under Credit Reform 


Illustration of How Spread Changes Can Affect the Final 


Expected Default Estimates 


9 

13 

19 

21 

24 

26 

71 

80 

88 

91 

Figure 10: Comparison of OMB Default Probabilities for Fiscal Years 

2004 and 2005 for ICRAS Category 1 with Moody’s 

Corporate Default Rates Used in OMB Model 

Page ii  GAO-04-531 Export-Import Bank 
Contents 

Figure 11: Comparison of OMB Default Probabilities for Fiscal Years 

2004 and 2005 for ICRAS Category 2 with Moody’s 

Corporate Default Rates Used in OMB Model 92 

Figure 12: Comparison of OMB Default Probabilities for Fiscal Years 

2004 and 2005 for ICRAS Category 3 with Moody’s 

Corporate Default Rates Used in OMB Model 93 

Figure 13: Comparison of OMB Default Probabilities for Fiscal Years 

2004 and 2005 for ICRAS Category 4 with Moody’s 

Corporate Default Rates Used in OMB Model 94 

Figure 14: Comparison of OMB Default Probabilities for Fiscal Years 

2004 and 2005 for ICRAS Category 5 with Moody’s 

Corporate Default Rates Used in OMB Model 95 

Figure 15: Comparison of OMB Default Probabilities for Fiscal Years 

2004 and 2005 for ICRAS Category 6 with Moody’s 

Corporate Default Rates Used in OMB Model 96 

Figure 16: Comparison of OMB Default Probabilities for Fiscal Years 

2004 and 2005 for ICRAS Category 7 with Moody’s 

Corporate Default Rates Used in OMB Model 97 

Figure 17: Comparison of OMB Default Probabilities for Fiscal Years 

2004 and 2005 for ICRAS Category 8 with Moody’s 

Corporate Default Rates Used in OMB Model 98 

Figure 18: Trends in ICRAS Expected Loss Rates for 8-Year Maturity 

Credits, in Present Value Terms, Fiscal Years 

1997-2005 100 

Page iii  GAO-04-531 Export-Import Bank 
Contents 

Abbreviations 

EL expected loss 


ECA export credit agency 


Ex-Im Bank Export-Import Bank 


FDIC Federal Deposit Insurance Corporation 


FRB Federal Reserve Board 


FASB Financial Accounting Standards Board 


GAAP generally accepted accounting principles 


ICRAS Interagency Country Risk Assessment System 


LGD loss given default 


OCC Office of the Comptroller of the Currency 


OMB Office of Management and Budget 


OECD Organization for Economic Cooperation and Development 


PD probability of default 


SEC Securities and Exchange Commission 


SFAS Statement of Financial Accounting Standards 


U.K. United Kingdom 


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Page iv  GAO-04-531 Export-Import Bank 
Page 1  GAO-04-531 Export-Import Bank 

A

United States Government Accountability Office 

Washington, D.C. 20548 

September 30, 2004 

The Honorable Richard C. Shelby 

Chairman 

The Honorable Paul S. Sarbanes 

Ranking Minority Member 

Committee on Banking, Housing and 

Urban Affairs 

United States Senate 

The Honorable Michael G. Oxley 

Chairman 

The Honorable Barney Frank 

Ranking Minority Member 

Committee on Financial Services 

House of Representatives 

As the official U.S. export credit agency (ECA), charged with providing 

financing to facilitate U.S. exports, the Export-Import Bank (Ex-Im Bank) 

issues loans, guarantees, and insurance products to foreign governments 

and corporations, primarily in developing countries. As of September 30, 

2003, Ex-Im Bank had a portfolio of about $61 billion.1

 Like any credit 

institution, the bank expects that some of the credit it offers will not be 

repaid, and it estimates these future losses for federal budget purposes 

according to the Federal Credit Reform Act of 1990.2

 The act requires that 

prior to entering into loans or loan guarantees, Ex-Im Bank must have 

budget authority for its “subsidy costs”—broadly speaking, estimates of net 

1

This portfolio valuation includes guarantees, loans receivable, insurance, receivables from 

subrogated claims, and undisbursed loans. Claims are made to Ex-Im Bank when a loan that 

it has guaranteed or an insurance policy that it has issued becomes overdue or defaults. 

2

Pub. L. No. 101-508. 

Page 1  GAO-04-531 Export-Import Bank 
losses on a present value basis.

3 The Office of Management and Budget 

(OMB) has overall responsibility for coordinating cost estimates under 

credit reform and plays a unique role in determining the subsidy costs of 

Ex-Im Bank and other federal agencies that offer international credit—it 

provides these agencies with expected loss rates, a key component of their 

subsidy costs.4

 For the fiscal year 2003 budget, OMB significantly changed 

its methodology for determining these rates.

5 In its annual financial 

statements, Ex-Im Bank also accounts for future expected losses by 

establishing loss allowances in accordance with private sector accounting 

standards.6 

The Export-Import Bank Reauthorization Act of 2002 directed GAO to 

report on the bank’s “reserve practices,” which include its approach for 

estimating subsidy costs.

7

 In response, we agreed to (1) describe OMB’s 

current and former methodologies for estimating expected loss rates for 

U.S. credit agencies’ international credit and the rationale for the recent 

revisions, (2) determine the impacts of the current methodology on Ex-Im 

Bank, and (3) assess the current methodology and the process by which it 

was developed. We also agreed to provide information on foreign ECA and 

commercial bank practices for estimating expected losses. 

3

The Federal Credit Reform Act defines the cost of a direct loan as the net present value (at 

the time of loan disbursement) of loan disbursements, principal repayments, and interest 

payments, adjusted for estimated defaults, prepayments, fees, penalties, and other 

recoveries. It defines the cost of a loan guarantee as the net present value (at the time the 

underlying loan is disbursed) of estimated payments by the government (for defaults and 

delinquencies, interest rate subsidies, and other payments) minus estimated payments to 

the government (for origination and other fees, penalties, and recoveries). When the present 

value of payments exceeds the present value of receipts—that is, when a credit program 

loses money—a positive subsidy exists. When the converse is true, a negative subsidy 

exists. 

4

The risk ratings assigned to transactions are also an important determinant of subsidy 

costs. Information on how risk ratings are determined for Ex-Im Bank is presented in the 

background section of this report, although an assessment of the appropriateness of ratings 

was outside the scope of this review. 

5

OMB made a small across-the-board downward adjustment to its expected loss rates for 

the fiscal year 2002 budget, but this did not entail a change in its basic methodology. 

6

Financial statement loss allowances consist of allowances for losses on loans and claims 

receivable and liabilities for losses on insurance and guarantee programs. These allowances 

are a measurement that reflects probable and estimable uncollectible loan balances or 

potential future liabilities, as required under private sector accounting standards. They are 

not tied directly to a funding request. 

7

Pub. L. No. 107-189, Sec. 14 (12 U.S.C. 635 note). 

Page 2  GAO-04-531 Export-Import Bank 
To describe and assess OMB’s current methodology for estimating 

expected loss rates, we obtained and evaluated analytical papers and OMB 

data and assumptions and discussed this information with OMB 

representatives. We reviewed an OMB paper that described the current 

methodology in theoretical terms and obtained more complete information 

by, on several occasions, posing questions to technical staff through OMB’s 

Office of General Counsel. While we obtained sufficient information to 

generally describe and assess key aspects of the methodology, we did not 

replicate or validate it. We also did not determine the reasonableness of 

specific loss rates that OMB has estimated. We note in the report where our 

description of certain aspects of the methodology is incomplete, but these 

areas were not material to our conclusions. We discussed the development 

of OMB’s loss estimation methodology with knowledgeable U.S. 

government officials. We also reviewed relevant research and discussed 

key issues with selected commercial banks, foreign ECAs and related 

government agencies, and credit experts. To determine the impact of the 

current methodology on Ex-Im Bank, we analyzed the bank’s budget and 

financial statement documents and discussed them with bank officials. 

Appendix I provides a more detailed description of our scope and 

methodology; appendixes II and III contain descriptions of foreign ECA 

and commercial bank practices for estimating expected losses. We 

conducted our review from November 2002 through March 2004 in 

accordance with generally accepted government auditing standards. 

Results in Brief 	 OMB developed its current methodology for determining expected loss 

rates, which lowered them, in part because of finance literature indicating 

that its former approach likely overstated losses to the government. OMB’s 

former methodology for estimating loss rates relied on interest rate 

differences—“spreads”—between bonds at different risk levels and lowrisk bonds such as U.S. Treasury bonds. The former methodology assumed 

that higher interest rates on bonds at different risk levels signaled the 

extent to which they presented higher probabilities of default and expected 

loss. The finance literature indicated that other factors in addition to 

expected losses, such as tax and liquidity considerations, influence interest 

rate differences. OMB’s current methodology uses rating agency corporate 

default data and interest rate spreads in a model it developed to estimate 

default probabilities and makes assumptions about recoveries after default 

to estimate expected loss rates. This methodology has generally predicted 

default rates somewhat lower than the underlying corporate rates it uses. 

Under the current methodology, expected loss rates for 8-year maturity 

credits were on average about 58 percent lower in fiscal year 2005 than in 

Page 3  GAO-04-531 Export-Import Bank 
fiscal year 2002, in risk categories in which Ex-Im Bank generally 

undertakes new financing. 

With lower loss rates, OMB’s current methodology has contributed to ExIm Bank projections of lower subsidy costs and budgetary requirements 

and influenced a modification in the way the bank calculates loss 

allowances for its financial statements. OMB’s new loss rates contributed 

to the bank’s request of smaller budget authority in fiscal years 2003 

through 2005 to cover its anticipated subsidy costs. In addition, in fiscal 

year 2003, Ex-Im Bank’s obligation of budget authority for subsidy costs 

dropped by almost half from fiscal year 2002, while the amount and 

estimated average risk of the bank’s new financing in those years was 

similar. When Ex-Im Bank reestimated the subsidy cost of its outstanding 

portfolio at the end of fiscal year 2002 using the new rates, these costs 

dropped by $2.7 billion, a decrease attributed by Ex-Im Bank officials 

primarily to OMB’s lower loss rates. Further, the fees that Ex-Im Bank 

charges to compensate for risk are now projected to generally provide 

greater coverage of its expected losses. During this period, Ex-Im Bank 

modified its approach for calculating financial statement loss allowances to 

be more in line with applicable accounting standards. This involved, among 

other things, diverging from its former practice of using the same loss rates 

to calculate loss allowances and subsidy costs. To maintain consistency in 

its loss allowance estimation and because of the changed nature of OMB’s 

loss rates, Ex-Im Bank generally began using higher loss rates for its loss 

allowances than it did for its subsidy costs. 

The OMB’s current methodology for estimating expected loss rates for U.S. 

agencies’ international credits involves challenges and is not transparent. 

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. More recent corporate 

default data than what OMB used shows higher defaults in some risk 

categories. In deciding to use this data to predict default, OMB analyzed 

Ex-Im Bank historical defaults over a somewhat narrow period. The default 

data analyzed did not cover other U.S. international credit agencies. OMB’s 

recovery rate assumptions have dropped twice since the methodology was 

implemented. The lower rates serve to offset lower default projections in 

the overall estimation of expected loss, but the basis for the recovery rates 

and the changes over time has not been transparent. Finally, despite the 

Page 4  GAO-04-531 Export-Import Bank 
complexity and implications of the current methodology, OMB developed it 

independently and provided affected agencies with limited information 

about its basis or structure. 

To improve the transparency of the subsidy cost estimation process and 

help ensure its validity, we are recommending that the Director of the 

Office of Management and Budget take five actions. First, we recommend 

that the Director provide affected U.S. agencies and Congress technical 

descriptions of OMB’s current method of determining expected loss rates. 

Second, we recommend that the Director provide similar information in the 

event of significant changes to its method for calculating expected loss 

rates. Third, we recommend that the Director ensure that OMB periodically 

update data from nonagency sources, such as the corporate default data 

used to estimate expected loss rates. Fourth, we recommend that the 

Director request from Ex-Im Bank and other U.S. international credit 

agencies the most complete and reliable information available on their 

default and repayment histories, so that the validity of the information on 

which the current methodology is based can be assessed over time. Finally, 

we recommend that the Director provide for, and document, independent 

methodological review of OMB’s expected loss model. 

Commenting on a draft of this report, OMB generally agreed to implement 

these recommendations. OMB also expressed concern about the report’s 

statement that its method for determining loss rates was not transparent, 

observing that our report generally describes the method. We believe that, 

while we do present in this report a substantial amount of information on 

OMB’s loss methodology, obtaining that information required considerable 

resources and effort, and similar information should be more readily 

available on an ongoing basis to affected agencies and Congress. Ex-Im 

Bank and the Comptroller of the Currency reviewed the report and made 

technical comments, which we incorporated where appropriate. The 

Department of the Treasury, the Federal Reserve Board, and the Federal 

Deposit Insurance Corporation did not have comments on the report. The 

Securities and Exchange Commission and the Department of Agriculture’s 

Foreign Agricultural Service reviewed parts of the report for technical 

accuracy; the Securities and Exchange Commission provided technical 

comments, which we incorporated where appropriate. We also obtained 

technical comments from bank and foreign ECA officials on our 

descriptions of their practices. 

Page 5  GAO-04-531 Export-Import Bank 
Background 	 Established in 1934, Ex-Im Bank is an independent U.S. government 

corporation that serves as the official ECA of the United States.

8

 Its mission 

is to support the export of U.S. goods and services overseas, thereby 

supporting U.S. export sector jobs. Ex-Im Bank’s mandate states that it 

should not compete with the private sector but rather assume the credit 

and country risks that the private sector is unable or unwilling to accept. 

Ex-Im Bank offers various financial products, such as direct loans, loan 

guarantees, export credit insurance, and working capital guarantees, to 

foreign buyers of U.S. goods and services and to U.S. exporters. In the last 

decade, new Ex-Im Bank authorizations of loans, guarantees, and 

insurance averaged nearly $12 billion per year. 

Because of its mandate, a large percentage of Ex-Im Bank’s business is with 

developing country borrowers that are typically considered more risky 

than borrowers in developed countries. Nearly 80 percent of Ex-Im Bank’s 

medium- and long-term exposure at the end of fiscal year 2003 was to 

borrowers from low- and middle-income countries.

9

 According to Ex-Im 

Bank officials, the types of borrowers it finances within countries have 

shifted over the last decade: whereas Ex-Im Bank historically financed 

foreign government (sovereign) purchases of U.S. exports, its new 

financing is now primarily for purchases by private sector borrowers. This 

shift is gradually being reflected in Ex-Im Bank’s portfolio of outstanding 

credits, which at the end of fiscal year 2003 included about 36 percent in 

financing to sovereign governments, about 46 percent in financing to 

foreign corporations, and about 18 percent in financing to public sector, 

nonsovereign borrowers. 

Both sovereign and private borrowers present some risk of failing to meet 

payment obligations (i.e., defaulting), potentially causing a financial loss 

for Ex-Im Bank and the U.S. government.10 In 1990, to more accurately 

measure the cost of federal credit programs, the government enacted credit 

8

Ex-Im Bank, which is subject to reauthorization every 4 to 5 years, was last reauthorized in 

June 2002. 

9

In grouping the countries for which Ex-Im Bank reported exposure in its 2003 financial 

statement, we used World Bank and Organization for Economic Cooperation and 

Development income classifications. 

10On a direct loan, default occurs when payments due to Ex-Im Bank are not made as 

scheduled. On a guaranteed loan, default occurs when payments due to the private sector 

lender are not made as scheduled, causing the lender to file a claim with Ex-Im Bank. 

Page 6  GAO-04-531 Export-Import Bank 
reform, which required agencies that provide domestic or international 

credit, including Ex-Im Bank, to estimate and request appropriations for 

the long-term net losses, or subsidy costs, of their credit activities.11 

According to credit reform, Ex-Im Bank incurs subsidy costs when 

estimated payments by the government (such as loan disbursements) 

exceed estimated payments to the government (such as principal 

repayments, fees, interest payments, and recovered assets), on a present 

value basis over the life of the loan. For each credit activity, Ex-Im Bank 

assesses the potential future losses based on the risk of the activity. It 

collects up-front fees or charges borrowers higher interest rates, or both, to 

offset that loss and receives subsidy appropriations to cover remaining 

losses. 

Credit reform requires credit agencies to have budget authority to cover 

subsidy costs before entering into loans or loan guarantees. Credit 

agencies, in their annual appropriations requests, estimate the expected 

subsidy costs of their credit programs for the coming fiscal year. Credit 

reform also requires agencies to annually reestimate subsidy costs of 

previous financing activity based on updated information. When 

reestimated subsidy costs exceed agencies’ original subsidy cost estimates, 

the additional subsidy costs are not covered by new appropriations but 

rather are funded from permanent, indefinite budget authority. 

To estimate their subsidy costs, credit agencies estimate the future 

performance of direct and guaranteed loans. Agency management is 

responsible for accumulating relevant, sufficient, and reliable data on 

which to base these estimates. To estimate future loan performance, 

agencies generally have cash flow models, or computer-based 

spreadsheets, that include assumptions about defaults, prepayments, 

recoveries, and the timing of these events and are based on the nature of 

their own credit program. Agencies that provide credit to domestic 

borrowers generally develop these cash flow assumptions, which OMB 

reviews, based on their historical experiences. For U.S. international 

credits, OMB provides the expected loss rates, which are composed of 

default and recovery assumptions, that agencies should use to estimate 

their subsidy costs. 

11Federal agencies that provide credit to the domestic market include the Departments of 

Agriculture, Education, Housing and Urban Development, and Veterans Affairs and the 

Small Business Administration. Federal agencies that provide international credit include 

the Departments of Agriculture and Defense and the Agency for International Development, 

Ex-Im Bank, and the Overseas Private Investment Corporation. 

Page 7  GAO-04-531 Export-Import Bank 
The determination of expected loss rates for federal agencies that provide 

international credit has two components: the assignment of risk ratings for 

particular borrowers or transactions and the determination of loss rates for 

each rating category, according to the maturity of the credit.

12 Both of these 

components, and their relationship to one another, are important in 

determining overall expected losses. For Ex-Im Bank, risk ratings are 

determined partly through an interagency process and partly by Ex-Im 

Bank’s risk management division. The appropriateness of these ratings is a 

key determinant in the overall appropriateness of Ex-Im Bank’s subsidy 

cost estimations.

13 

Through the Interagency Country Risk Assessment System (ICRAS),14 

which OMB chairs, ICRAS agencies determine risk ratings that will be in 

effect each fiscal year (see box 1 in fig. 1).

15 There are two types of ICRAS 

ratings—one for foreign government (sovereign) borrowers and one for the 

private sector climates in foreign countries. Ratings range from 1 (least 

risky) to 11 (most risky). Ratings for sovereign borrowers are based on 

macroeconomic indicators, such as indebtedness levels; balance-ofpayments factors; and political and social factors. In determining ratings, 

the agencies take into account country risk ratings assigned by private 

sector ratings agencies and by the Organization for Economic Cooperation 

12These expected losses are estimates, based on available information, of the mean, or 

average, level of future losses expected from particular credit activities. Actual losses can 

be higher or lower than the expected losses. 

13Evaluating the risk rating process or the reasonableness of specific ratings was beyond the 

scope of this engagement. 

14ICRAS was established in 1991 to create uniformity among the federal agencies involved in 

providing international credit. According to OMB, these agencies had previously used 

separate methodologies for estimating their subsidy costs, which often produced different 

default expectations for the same debtor. The ICRAS working group is chaired by OMB and 

includes representatives from the cross-border financing agencies, including Ex-Im Bank, 

the Departments of Agriculture and Transportation, the Overseas Private Investment 

Corporation, the Agency for International Development, and the Defense Security 

Assistance Administration. Other interested government organizations, including the 

Departments of Treasury, State, and Commerce; the Federal Reserve; the Council of 

Economic Advisors; and the National Security Council are also represented. 

15The ICRAS ratings for some countries are reviewed yearly, while others are reviewed less 

frequently. Some ratings may be revised more frequently depending on circumstances. 

Page 8  GAO-04-531 Export-Import Bank 
and Development (OECD).16 Private sector ratings assigned through the 

ICRAS process also take into account factors such as the banking system 

and legal environment in a country. Ex-Im Bank generally authorizes, with 

few exceptions, new business for borrowers with ICRAS ratings of 8 or 

better.

17 (App. IV contains more information about the ICRAS risk rating 

process.) 

Figure 1: Components of the ICRAS Process 

ICRAS assigns risk ratings 

OMB determines expected 

loss rates by risk rating 

1. Ex-Im Bank economists assess 

macroeconomic factors and draft papers, 

which propose sovereign and private 

sector ratings from 1- 11. 

1. OMB determines expected loss rates for 

each ICRAS risk rating and maturity, 

which agencies use, combined with their 

own cash flow assumptions, to calculate 

their subsidy costs and budgetary needs. 

2. OMB distributes the papers to the ICRAS 

participants for review. 

3. Ratings are approved by the interagency 

group. Discussions are held when 

members raise significant questions. 

Sources: GAO analysis of Ex-Im Bank and OMB documents. 

For Ex-Im Bank’s financing with foreign governments, the ICRAS sovereign 

risk rating applies. For Ex-Im Bank’s private sector lending, Ex-Im Bank 

officials assign risk ratings. According to Ex-Im Bank officials, they use 

private rating agency ratings for a corporation when the ratings are 

available, which is the case for a minority of borrowers. For most private 

sector borrowers, Ex-Im Bank officials use the private sector ICRAS rating 

16These comparisons are made based on a table, or concordance, that sets up a cross-walk 

between ICRAS ratings and the ratings of major private rating agencies, such as Moody’s 

Investors Service and Standard & Poor’s, as well as between ICRAS ratings and OECD 

ratings. 

17Ex-Im Bank’s Country Limitation Schedule identifies the countries for which the bank’s 

support is not available or for which limitations on available credit length exist. See 

http://ww.exim.gov/tools/country/country_limits.html. 

Page 9 GAO-04-531 Export-Import Bank 
as a baseline and adjust that rating depending on their assessment of the 

borrower’s creditworthiness.

18 

For the second component, OMB plays a key role. It determines expected 

loss rates for each ICRAS risk rating and maturity, which U.S. agencies that 

provide international credit use in preparing their subsidy cost estimates 

(see fig. 1, box 2). OMB provides these loss rates to ICRAS agencies each 

fiscal year, in time to be used in preparing budget submissions.19 To 

estimate future cash flows, ICRAS agencies use OMB’s expected loss rates 

in their cash flow models. The loss rates are also used to allocate subsidy 

costs during the fiscal year and to calculate subsidy cost reestimates at the 

end of the fiscal year. OMB also provides agencies with a credit subsidy 

calculator, which has been audited, that agencies use to convert agencyestimated cash flows into present values.20 

The credit reform act resulted in the establishment of a special budget 

accounting system to track inflows and outflows associated with agencies’ 

lending activities. Expected long-term subsidy costs for financing activities 

in a fiscal year appear in an agency’s annual budget submission and are 

subject to congressional approval. However, any increases over time in 

expected subsidy costs for financing that took place in earlier years are 

financed from permanent indefinite budget authority and do not have to be 

appropriated in the annual appropriations process.21 In the case of Ex-Im 

Bank, such changes could result, for example, from changes in the risk 

assessment for certain countries or changes in loss assumptions for a given 

18For medium-term transactions of less than $10 million (which represent less than 10 

percent of Ex-Im Bank’s portfolio), the bank uses a portfolio approach to assign rating 

categories, assigning an overall category to a country. According to Ex-Im Bank officials, the 

category assigned to these transactions is generally one risk category higher than the private 

sector ICRAS rating for the country. 

19For credit programs, OMB also provides the discount rates that are used to calculate 

subsidy estimates. These rates are built into OMB’s credit subsidy calculator. 

20PricewaterhouseCoopers LLP audited the credit subsidy calculator in December 1999 to 

ensure that the calculations it is designed to make are done correctly. The calculator was 

audited because users, as well as the accountants and auditors who prepare and audit 

agency financial statements, need to have assurance that it calculates reliable subsidy costs 

in compliance with applicable legislation and accounting standards. 

21Permanent budget authority is available as the result of previously enacted legislation and 

does not require new legislation for the current year. Indefinite budget authority is budget 

authority of an unspecified amount of money. 

Page 10 GAO-04-531 Export-Import Bank 
risk level. (App. V contains additional information about the credit reform 

budget accounting system.) 

In addition to estimating expected losses for budgetary purposes, Ex-Im 

Bank measures the expected loss of its portfolio in its own annual audited 

financial statements. As a government corporation, Ex-Im Bank is required 

to follow “principles and procedures applicable to commercial corporate 

transactions.”22 Ex-Im Bank’s financial statements are prepared according 

to private sector generally accepted accounting principles (GAAP) that 

require Ex-Im Bank to follow Financial Accounting Standards Board 

(FASB) accounting guidance when establishing allowances for future 

expected credit losses. 

OMB Developed New 

Method That Lowered 

Expected Loss Rates 

OMB developed its current methodology for determining expected loss 

rates for ICRAS agencies, which lowered these rates, based in part on 

evidence that its former approach overstated likely defaults and losses. For 

fiscal years 1992-2002, OMB based its expected loss estimates on 

differences between interest rates on bonds of different risk levels. In 

developing its current approach, OMB cited emerging academic literature 

that indicated its former approach may have overestimated likely costs to 

the government. Ex-Im Bank officials also said they believed, based on 

their reestimates, that their subsidy cost appropriations had been too high 

relative to their loss experience since the beginning of credit reform. OMB’s 

current approach uses historical corporate bond default data, adjusted for 

trends in interest rate spreads, to predict defaults and applies an 

assumption regarding recovery rates to estimate expected loss rates. Under 

the current approach, loss rates across most risk categories dropped 

significantly. 

OMB’s Former Methodology 

Based Expected Loss 

Estimates on Differences in 

Bond Interest Rates 

The method that OMB used in fiscal years 1992-2002 based expected loss 

rates for ICRAS agencies on interest rate spreads between publicly traded 

U.S. corporate or foreign government bonds and low-risk bonds such as 

22The Government Corporation Control Act of 1945 required wholly owned government 

corporations, including Ex-Im Bank, to follow private sector principles and procedures. 

Since 1990, the act has required such corporations to undergo annual audits by independent 

public accountants. 

Page 11 GAO-04-531 Export-Import Bank 
U.S. Treasury bonds.23 Under this method, estimates of expected loss 

shifted as the underlying spread data shifted. Interest rate spreads are an 

indicator of expected loss, in that the size of a spread tends to widen as the 

perceived risk increases. For example, when interest rates on a foreign 

bond are 6 percent and U.S. Treasury bond interest rates are 5 percent, the 

spread between the two is 1 percentage point. The foreign bond in this 

example provides a higher rate of interest than the U.S. Treasury bond 

because creditors require a higher return on their capital, at least in part 

because they perceive that foreign bonds carry a higher risk of nonrepayment. 

Spreads fluctuate over time depending in part on changes in market views 

of borrowers’ creditworthiness. Figure 2 shows interest rate spreads for 

Argentine, Russian, and Mexican government bonds over U.S. Treasury 

bonds from 1999-2003, illustrating how spreads can fluctuate. Spreads 

increased sharply in 2001 for the Argentine bonds, as Argentina’s default on 

those bonds was imminent. Conversely, the spread for the Russian bonds 

shown narrowed over the period as Russia’s economy improved, while the 

spreads for the Mexican bonds were consistently the smallest of the three 

countries. 

23In these years, OMB presented its loss rates, for most ICRAS categories, in terms of risk 

premiums, which were estimated average differences between the interest rates on traded 

bonds in a risk category and the U.S. Treasury bond rate. The default costs, or expected 

losses, associated with those risk premiums were estimated to be the difference between 

the present value of the loan or loan guarantee’s expected cash flows discounted at the 

Treasury interest rate and the expected cash flows discounted at the risk-adjusted interest 

rates. 

Page 12 GAO-04-531 Export-Import Bank 
Figure 2: Trends in Interest Rate Spreads for Argentine, Russian, and Mexican Government Bonds as Compared to U.S. 

Treasury Bonds, 1999-2003

Percentage points

60

50

40

30

20

10

0

1999 2000 2001 2002 2003

Year

Argentina 

Mexico 

Russia 

Source: GAO analysis of bond price data from Global Insight. 

OMB has used varying underlying instruments to calculate bond spreads 

and expected losses for ICRAS agencies. In the beginning of credit reform, 

OMB used the spreads on U.S. corporate bonds at different risk levels to 

estimate risk premia (and thus expected loss).24 That is, OMB determined 

the interest rate spread for U.S. corporate bonds within a risk rating 

category and used those spreads to compute a risk premium for each 

24Initially, the spreads were computed relative to the lowest risk, or AAA, corporate bonds. 

Later, OMB computed the spreads relative to U.S. Treasury bonds. 

Page 13 GAO-04-531 Export-Import Bank 
ICRAS category. In fiscal year 1997, OMB began using the interest rate 

spreads on other instruments, including foreign government bonds.25 

After interest rates on some types of international bonds rose in the late 

1990s, OMB determined that basing expected loss rates only on interest 

rate spreads resulted in estimates that were too high. According to OMB, it 

was decided in the discussions within the executive branch and with 

Congress leading to credit reform that only the expected cost to the 

government was relevant for estimating default losses to the government 

under credit reform. OMB decided to change its method for determining 

default losses, primarily because emerging research showed that factors 

other than expected losses from defaults account for a significant portion 

of interest rate spreads.26 According to this literature, differences in 

liquidity and tax considerations, and an aspect of credit risk that OMB 

termed “portfolio risk,” affect interest rates on international bonds.27 

Studies cited by OMB and other related literature indicate that factors 

other than expected losses from defaults account for a high proportion of 

interest rate spreads—in some cases, most of the spread—especially on 

higher-quality bonds. For bonds with risk ratings that correspond to the 

riskier ICRAS rating categories, 5 and higher (riskier), conclusions from the 

literature that OMB cited and other literature that we reviewed are less 

clear. One study cited by OMB found that differences in tax treatment, and 

compensation for risk beyond expected losses, explained most of interest 

rate spreads; however, because of limited data, that study did not include 

bonds in risk categories higher than those corresponding to ICRAS 

25We reported in 1994 that expected losses using this method were based on small numbers 

of spread observations in some ICRAS categories. See GAO, Credit Reform: U.S. Needs 

Better Method for Estimating Cost of Foreign Loans and Guarantees, NSIAD/GGD-95-31 

(Washington, D.C.: Dec. 19, 1994). 

26Literature cited by OMB included, in part, Jerome S. Fons, “Using Default Rates to Model 

the Term Structure of Credit Risk,” Financial Analysts Journal 50 (1994): 25-32; and Edwin 

Elton, Martin J. Gruber, Deepak Agrawal, and Chrisotopher Mann, “Explaining the Rate 

Spread for Corporate Bonds,” Journal of Finance 56 (2001): 247-277. 

27“Portfolio risk” is the risk associated with the variability of default rates—the likelihood 

that losses from defaults will be higher in some periods than others. This portfolio risk, 

although related to default costs, is not included in OMB’s calculation of expected losses 

because, according to OMB, it is not considered to be a cost to the government and, thus, is 

not a cost for which the U.S. government would need to budget. 

Page 14 GAO-04-531 Export-Import Bank 
category 4.28 A second study cited by OMB found that market interest rate 

spreads on bonds were greater than those that would be predicted based 

on corporate default data. The differences were particularly apparent for 

bonds in investment-grade categories and were smaller for speculativegrade bonds.29 

For the fiscal year 2002 budget, OMB imposed an across-the-board 

reduction in the expected loss estimates for ICRAS risk categories 1 

through 8.30 OMB said that it did this to eliminate part of the spread 

between other bonds and U.S. Treasury bonds to come closer to measuring 

only default cost. The risk factors and expected loss estimates for the 

bottom three categories did not change. 

A further rationale for adjusting the expected loss rates, according to ExIm Bank officials, was that the bank had calculated several downward 

reestimates of its subsidy costs since the inception of credit reform. They 

viewed this as evidence that the bank’s original subsidy cost estimates were 

conservative. According to Ex-Im Bank officials, several factors influence 

the bank’s subsidy cost reestimates, including changes in the outstanding 

balance of its cohorts (the term “cohort” refers to the financing extended in 

a given fiscal year, which Ex-Im Bank further subdivides by product type); 

changes in cohort performance or average riskiness; and changes in OMB’s 

expected loss rates.31 Ex-Im Bank calculated a net downward reestimate of 

about $368 million in fiscal year 1999, followed by a larger net downward 

reestimate of about $1.4 billion in fiscal year 2000 and a subsequent net 

28Elton et.al., “Explaining the Rate Spread for Corporate Bonds.” 

29Fons, “Using Default Rates to Model the Term Structure of Credit Risk.” 

30This amount of the reduction was based on the amount by which the default probability 

implied by interest rate spreads for ICRAS A-rated credits was greater than published 

default probabilities for AA and AAA-rated corporations. 

31According to an Ex-Im Bank official, the bank calculates subsidy cost reestimates at the 

end of the fiscal year using an approach that is similar but not identical to one of the two 

approaches specified under credit reform. Ex-Im Bank officials said that to reestimate the 

subsidy cost of each cohort, they determine the outstanding principal balance at the end of 

the fiscal year, the weighted average remaining term to maturity, and the weighted average 

risk rating. They apply the most current OMB expected loss rate that corresponds to each 

cohort’s average risk rating to the cohort’s outstanding principal balance to determine the 

cohort’s reestimated subsidy cost. They compare that amount with the amount already set 

aside for the cohort. If reestimated subsidy costs are less than the amounts set aside the 

previous fiscal year, this would result in a downward reestimate, the amount of which is 

transferred from Ex-Im Bank’s financing account to the Treasury. 

Page 15 GAO-04-531 Export-Import Bank 
downward reestimate of about $300 million in fiscal year 2001.32 (In these 

years, upward reestimates of some cohorts were more than offset by larger 

downward reestimates of other cohorts.) There were small net downward 

and upward reestimates in fiscal years 1992 through 1995, and Ex-Im Bank 

did not calculate reestimates in fiscal years 1996 through 1998. Ex-Im 

Bank’s reestimates represent the bank’s ongoing assessment of the 

riskiness of its post-credit reform financing at a given point in time and are 

not a final assessment of the performance of cohorts that have not reached 

maturity at the time of the reestimate. An Ex-Im Bank official noted that 

future claims or defaults could occur on cohorts that have not reached 

maturity, possibly causing upward reestimates to certain cohorts in the 

future. 

OMB’s Current Methodology 

Bases Expected Loss Rates 

on Corporate Default Data, 

Interest Rate Spreads, and 

Recovery Assumptions 

OMB’s current methodology uses rating agency corporate default data and 

interest rate spreads to estimate default probabilities and makes 

assumptions about recoveries after default to estimate expected loss rates. 

The methodology estimates default rates for federal international credits 

using a complex model that OMB developed. These rates were generally 

lower for fiscal years 2004 and 2005 than the underlying corporate default 

rates that OMB used in estimating its rates. OMB introduced its current 

methodology, which estimates expected loss rates for ICRAS categories 1 

through 8, for use in fiscal year 2003, and made modifications for fiscal 

years 2004 and 2005.33 (App. VI contains a technical description of the 

methodology.) 

32Information in this report about Ex-Im Bank’s reestimates is based on information that the 

bank provided for each year in which it calculated reestimates. This information differs 

slightly in some years from information about the bank’s reestimates that is reported in the 

Federal Credit Supplement to the budget. These figures reflect only the subsidy cost portion 

of the reestimates cited. Ex-Im Bank also calculates interest costs on the subsidy costs, but 

these costs are not included in the figures. 

33Expected losses for ICRAS categories 9 through 11 are calculated differently. They are 

based on market prices (interest rates) on debt issues of countries in these categories. 

According to OMB, it averaged the limited interest rate observations of international debt 

for countries in each category. OMB obtained the data from the International Finance 

Review and WesBruin Capital. OMB changed its method for fiscal year 2004 (1) to exclude 

collateralized instruments; (2) for performing bonds, to adjust for the difference between 

bond coupon rates and Treasury rates, excluding issues with unknown coupon rates; and (3) 

to apply a discount to each ratings category (5 percent for category 9, 10 percent for 

category 10, and 25 percent for category 11) to reflect that countries with high ratios of 

bilateral debt (debt owed to other countries) to private debt are more likely to expect debt 

reduction. 

Page 16 GAO-04-531 Export-Import Bank 
OMB Model Bases Default 

Estimates on Corporate Default 

Data and Spreads 

OMB uses rating agency corporate default data and information on interest 

rate spreads to determine expected defaults through a complex model. The 

model has two empirical relationships, one between ratings and defaults 

and the other between interest rate spreads and defaults. The model 

combines the relationships to arrive at OMB’s expected default rates across 

ICRAS risk categories. Historical default rates on corporate bonds by risk 

rating category are the key inputs to both components of the model. 

The first component of the model bases the probability that ICRAS agency 

borrowers will default on default rates for corporate bonds published in 

2000 by a nationally recognized private rating agency, Moody’s Investors 

Service. The risk categories associated with the Moody’s corporate default 

probabilities are converted to ICRAS risk categories.34 OMB’s model uses 

two Moody’s data series on U.S. corporate bond defaults, which OMB 

combined into a single series. The data series used for the four lowest-risk 

ICRAS categories (1-4) includes default rates on rated corporate bonds by 

risk rating category during 1920-1999. The data series used for the next four 

(higher risk) ICRAS categories (5-8) includes default rates on rated 

corporate bonds by risk rating category during 1983-1999.35 

The second component of the model uses data on interest rate spreads to 

make adjustments to the same Moody’s historical default data. The current 

method does not use spread information as the primary indicator of default 

risk, as OMB’s former method did. Instead, it uses spread information as a 

signal of how current market conditions might differ from those reflected 

in the Moody’s historical data. The model is designed to adjust historical 

default rates by rating category up or down in cases where interest rate 

spreads in a category are unusually high or low relative to the average 

spreads for that category. The adjustment in the model gives greater 

weights to more recent spreads in calculating the averages. To estimate this 

relationship, OMB used interest rate data on international bonds from 

Bloomberg. 

34Moody’s ratings are themselves determined by the likelihood of default (default rates) and 

the severity of default (recovery rates), according to a Moody’s official and agency 

documents. 

35OMB converted the default probabilities in the Moody’s tables to default probabilities for 

ICRAS ratings by averaging certain values within each table and making some judgmental 

decisions, which, according to OMB, generally resulted in choosing values on the higher 

side of the Moody’s ratings when there was not a straight match with ICRAS categories. 

Page 17 GAO-04-531 Export-Import Bank 
The default probabilities reflected in OMB’s expected loss rates for fiscal 

years 2004 and 2005 were generally lower than the corporate default rates 

that OMB used in its model. Figure 3 illustrates OMB’s fiscal year 2004 and 

2005 default probabilities for 1-8 years for three ICRAS ratings categories 

and the Moody’s corporate default rates for corresponding risk 

categories.36 The graph shows that OMB default probabilities are somewhat 

lower than the corporate default rates for the ratings categories shown. 

(App. VII presents similar comparisons for ICRAS categories 1-8.) Based on 

information we obtained on OMB’s model, this difference would be 

expected to result from interest rate spreads’ trending significantly 

downward for some rating and maturity categories. It could also result 

from features of the model specification. We could not determine the 

reasons for the difference because we did not replicate OMB’s model and, 

in response to our questions, OMB did not identify specific reasons for the 

differences. (App. VI contains more information about model specification 

issues.) 

36We compared the Moody’s and OMB’s default rates for maturities of 1-8 years because the 

combined Moody’s series that OMB used had only 8 years of default rates for ICRAS 

categories 5 through 8. 

Page 18 GAO-04-531 Export-Import Bank 
Figure 3: Comparison of OMB Default Probabilities for Fiscal Years 2004 and 2005 and Moody’s Corporate Default Rates Used in 

OMB Model for Selected Rating Categories 

ICRAS score: 4 ICRAS score: 6 ICRAS score: 8

Percentage default rate or probability 

50 

40 

30 

20 

10 

0 

1 2 3 4 5 6 7 8 

Years to maturity 

Methodology Combines Default 

Rates and Recovery Rates to 

Determine Expected Losses 

Percentage default rate or probability 

50 

40 

30 

20 

10 

0 

1 2 3 4 5 6 7 8 

Years to maturity 

Corporate default rates used in OMB model 

FY 2005 OMB default probability 

FY 2004 OMB default probability 

Source: GAO analysis of OMB data. 

Percentage default rate or probability 

50 

40 

30 

20 

10 

0 

1 2 3 4 5 6 7 

Years to maturity 

Note: OMB default probabilities were calculated from the expected loss rates that OMB generated for 

the fiscal year 2004 and fiscal year 2005 budgets. The OMB default probabilities are calculated by 

removing the recovery rate adjustments (12 percent for fiscal year 2004 and 9 percent for fiscal year 

2005) from the net default probability tables provided by OMB, which had recovery rates factored in. 

After determining expected default rates, OMB combines the default rates 

with an assumption about the recovery rate—the percentage of defaulted 

principal and interest that will be recovered over time—to obtain expected 

loss rates.

37 The assumed recovery rate is a key driver of the expected loss 

rates. OMB assumed an across-the-board recovery rate of 17 percent for 

the fiscal year 2003 budget—that is, the government was expected to lose 

$830 and recover $170 for every $1,000 in defaulted credits. It assumed 

37Expected loss is equal to expected default multiplied by one minus the recovery rate. Thus, 

an expected default rate of 15 percent and a recovery rate of 20 percent would result in an 

expected loss rate of 12 percent. (This is expressed mathematically as 15 (1 - .20) =15 (.80) = 

12.) 

Page 19 GAO-04-531 Export-Import Bank 

8
lower recovery rates of 12 percent for the fiscal year 2004 budget and 9 

percent for the fiscal year 2005 budget. 

OMB’s Current Methodology 

Lowered Expected Loss 

Rates 

OMB’s current methodology reduced the loss rates that U.S. credit agencies 

are expected to incur on international credits they provide. Between fiscal 

years 2002 and 2005, expected loss rates fell across ICRAS risk categories 1 

through 8.38 As shown in figure 4, expected loss rates for credits of 8-year 

maturity were, on average, about 58 percent lower on a present value basis 

in fiscal year 2005 than 2002 (the last fiscal year in which OMB used its 

former approach to develop the loss rates).

39 The largest declines were in 

risk categories 1 through 5. Expected loss rates for ICRAS agencies have 

varied over the credit reform period. (See app. VIII for information on 

trends in expected loss rates for ICRAS agencies between fiscal years 1997 

and 2005.) 

38Loss expectations rose slightly between fiscal years 2002 and 2005 for ICRAS categories 9 

and 10 and declined slightly for category 11. 

39We compared the loss expectations in place for 8-year guarantees at ICRAS risk ratings 1-8 

using Ex-Im Bank’s cash flow worksheets and determined their present value using OMB’s 

credit subsidy calculator. We selected 8-year credits because this maturity is representative 

of many Ex-Im Bank credits. Specific loss expectations per ICRAS category differ 

depending on the maturity of the credit, but the general trend and average reduction over 

the period were similar for the other maturity bands we analyzed. 

Page 20 GAO-04-531 Export-Import Bank 
Figure 4: Comparison of OMB’s Expected Loss Rates, in Present Value Terms, for ICRAS Risk Categories 1-8, Fiscal Years 2002

2005 

Percentage expected loss rate 

40 

35 

30 

25 

20 

15 

10 

5 

0 

1 2 3 4 5 6 7 8

low risk ICRAS rating high risk 

Fiscal year 

2002 

2003 

2004 

2005 

Source: GAO analysis of OMB expected loss rates. 

Note: The figure compares loss expectations that were in place in each fiscal year, in present value 

terms, for each ICRAS risk category based on guarantees of 8-year maturity. We based the analysis 

on 8-year maturities because this maturity is representative of many Ex-Im Bank credits. 

For fiscal year 2003, the first year for which OMB’s current methodology 

was used to develop expected loss rates, rates declined sharply across 

most ICRAS risk categories. Loss rates for fiscal year 2004 rose for several 

risk categories, with the biggest change being an increase in the loss rate 

for ICRAS risk category 6. According to OMB, the expected loss rates 

changed from fiscal year 2003 to 2004 because of updated country ratings 

and interest rate data. OMB did not provide more specific information to 

explain those changes. Also, the lower recovery rate assumptions used in 

Page 21 GAO-04-531 Export-Import Bank 
fiscal year 2004 would be expected to push loss rates upward. Expected 

loss rates in fiscal year 2005 were generally similar to those in fiscal year 

2004, with slight declines for some risk categories. Although OMB’s model 

generated lower default rates for fiscal year 2005 than for fiscal year 2004, a 

further decrease in its recovery rate assumptions resulted in little change to 

expected loss rates in fiscal year 2005. 

Current OMB 

Methodology Has 

Lowered Ex-Im Bank’s 

Projected Subsidy 

Costs and Budgetary 

Needs 

By lowering loss rates for most ICRAS risk categories, OMB’s current 

methodology has contributed to lower Ex-Im Bank projections of subsidy 

costs and, therefore, lower budgetary requirements. Ex-Im Bank’s 

obligation of budget authority for new subsidy costs declined significantly 

for fiscal year 2003, when the current methodology took effect. In addition, 

Ex-Im Bank calculated a large downward reestimate of the subsidy costs of 

its outstanding portfolio at the end of fiscal year 2002 using the new loss 

rates. With lower loss rates, Ex-Im Bank’s fees are generally projected to 

provide greater coverage of expected losses, fully offsetting losses in some 

budget categories. Finally, during this period, Ex-Im Bank modified its 

approach for calculating loss allowances in its financial statements. This 

involved making certain changes to be more in line with applicable 

accounting standards and, because of the changed nature of OMB’s loss 

rates, using different and higher loss rates than it used in its budget 

documents to calculate subsidy costs. 

Lower OMB Loss Rates 

Reduce Ex-Im Bank Budget 

Authority Needed to Cover 

Subsidy Costs 

Partially because of OMB’s lower loss rates, Ex-Im Bank required less 

budget authority to cover its lower subsidy costs. Estimates and obligation 

of budget authority for subsidy costs are determined by the amount and 

risk of business the bank expects to, or does, undertake in a year, as well as 

expected loss rates and fees charged to borrowers. Changes in any one of 

those factors can alter budget needs. According to Ex-Im Bank officials, 

OMB’s lower loss rates were a key determinant in the declines in its subsidy 

cost estimates, its budget authority obligated for new subsidy costs, and its 

2002 reestimate of subsidy costs. 

Ex-Im Bank’s requests for budget authority for subsidy costs have dropped 

since it began using the lower loss rates to estimate subsidy costs. The 

bank’s request for subsidy budget authority in fiscal year 2003 was about 30 

percent lower than the average of its requests in the previous 5 years, partly 

because of lower OMB loss rates and partly because of a substantial 

Page 22 GAO-04-531 Export-Import Bank 
amount of budget authority carried over from the previous fiscal year.

40 ExIm Bank requested no new subsidy budget authority in fiscal year 2004 but 

anticipated $460 million in new subsidy cost obligations.41 The amount of 

budget authority carried over from previous fiscal years was seen as 

sufficient to cover anticipated fiscal year 2004 subsidy costs.42 Ex-Im Bank 

requested $126 million for subsidy budget authority in fiscal year 2005, but 

it anticipated $491 million in obligations for subsidy costs.

43 The bank 

continued to have a significant amount of budget authority carried over to 

fund the difference. 

In addition, Ex-Im Bank’s obligation, or usage, of budget authority for new 

subsidy costs dropped when the current methodology took effect, as 

shown in figure 5. The bank’s obligation of subsidy budget authority had 

dropped in fiscal years 2001 and 2002, in part because of reductions in new 

financing in those years. Its obligation of budget authority for new subsidy 

costs in fiscal year 2003 was about 55 percent lower than in fiscal year 

2002, even though the total amount of its new financing, and Ex-Im Bank’s 

estimate of its average risk level, in these two fiscal years was similar.

44 

40The bank’s appropriations in a given fiscal year can be carried over for up to 3 years if they 

are not completely obligated. This would happen, for example, in years when the actual 

amount and risk ratings of new financing the bank undertook in a fiscal year were lower 

than had been anticipated for that year. 

41The figure includes anticipated obligations of $440 million for direct and guaranteed loan 

subsidies and $20 million for direct and guaranteed loan modifications. 

42The carryover resulted in part from Ex-Im Bank obligating substantially less budget 

authority in fiscal year 2003 than it expected. In its budget submission, the bank expected to 

obligate about $655 million for new subsidy costs and modifications. However, it obligated 

about $334 million of the $513 million it was authorized for subsidy costs in fiscal year 2003. 

43The bank anticipated obligations of $471 million for direct and guaranteed loan subsidies 

and $20 million for direct and guaranteed loan modifications. 

44In 2002, Ex-Im Bank authorized about $10.1 billion in new financing, with an average 

ICRAS risk weight of 4.9; its obligation of subsidy budget authority that year was about $738 

million. In fiscal year 2003, Ex-Im Bank authorized about $10.5 billion in new financing, with 

an average ICRAS risk weight of 5.0; its obligation of subsidy budget authority that year was 

about $334 million. 

Page 23 GAO-04-531 Export-Import Bank 
Figure 5: Ex-Im Bank Obligation of Budget Authority for New Subsidy Costs, Fiscal 

Years 1992-2003 

Dollars in millions 

1,000 

900 

800 

700 

600 

500 

400 

300 

200 

100 

0 

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 

Fiscal year 

Source: GAO analysis of Ex-Im Bank Financial Highlights. 

Note: Figure excludes subsidy budget authority obligated for purposes of tied-aid (government-togovernment concessional financing of public sector capital projects in developing countries that is 

linked to the procurement of goods and services from the donor country). 

According to Ex-Im Bank officials, OMB’s lower loss rates also contributed 

to a significant downward reestimate of the subsidy costs of the bank’s 

outstanding credits, based on its first subsidy cost reestimate that used the 

lower rates.

45 At the end of fiscal year 2002, using the OMB loss rates for 

45When calculating its reestimates, Ex-Im Bank uses the most current OMB loss rates 

available. According to Ex-Im Bank officials, its reestimate in fiscal year 2002 was 

calculated using fiscal year 2004 loss rates. The officials said that the fiscal year 2003 loss 

rates were not used for any reestimate calculations. 

Page 24 GAO-04-531 Export-Import Bank 
fiscal year 2004, Ex-Im Bank calculated a net downward reestimate of 

about $2.7 billion, significantly lowering its estimated subsidy costs for 

outstanding credits.46 Downward reestimates on long-term guarantees 

represented about 72 percent of the reestimate. About 63 percent of the 

reestimate was calculated on financing extended between fiscal years 1997 

and 2001, much of which has likely not yet matured.47 

With Lower Loss Rates, ExIm Bank Fees Are Projected 

to Provide Greater Coverage 

of Losses 

With the decline in OMB’s loss rates, Ex-Im Bank’s exposure fees are 

projected to generally provide greater coverage of its expected losses.48 

The determination of the relationship between exposure fees and expected 

losses and, thus, the calculation of budget subsidy cost, depends on the risk 

rating for specific Ex-Im Bank transactions. Ex-Im Bank generally sets its 

exposure fees at, or in the case of some corporate transactions slightly 

above, the minimum level required by an agreement among certain OECD 

member countries.49 

This agreement among OECD countries was designed to increase 

transparency and provide common benchmarks for ECA exposure fees, 

thereby reducing fee competition among exporters. Participating ECAs 

may charge fees above the OECD minimum if they do not view the fees as 

sufficient to cover their expected losses on a given transaction, but they are 

expected to charge at least the minimum. For private sector transactions, 

46The total downward reestimate that Ex-Im Bank calculated in fiscal year 2002 was about 

$3.5 billion, of which $2.7 billion was reestimated subsidy cost and $0.8 billion was interest 

cost. At the end of fiscal year 2003, Ex-Im Bank calculated a net downward reestimate of 

about $1.9 billion, of which about $1.4 billion was reestimated subsidy costs and about $0.5 

billion was interest costs. 

47Percentages on the 2002 reestimates were calculated on subsidy and interest costs 

combined because information on the trends by cohort was available only in this format. 

48Exposure fees are fees that Ex-Im Bank charges borrowers to cover the risk that the 

transaction will not be repaid. These fees vary depending on the risk and tenor of the credit 

being offered. Ex-Im Bank also charges other fees, including application processing fees and 

commitment fees. 

49This agreement was among Participants to the Arrangement on Officially Supported 

Export Credits. Participants to the Arrangement are Australia, Canada, the members of the 

European Community, Japan, the Republic of Korea, New Zealand, Norway, Switzerland, 

and the United States. The fee agreement, sometimes called the Knaepen Package after the 

Belgian official instrumental in its formation, was concluded in 1997 and took effect in 1999. 

The fees in the agreement result from a political agreement, an averaging of fees in place in 

1996 across certain export credit agencies. 

Page 25 GAO-04-531 Export-Import Bank 
participating ECAs that we spoke with often charge fees above the OECD 

minimum fees. (See app. II for additional information on the OECD 

minimum fee determination process.) 

Using fiscal year 2005 expected loss rates, Ex-Im Bank exposure fees at the 

OECD minimum fee level would be projected to fully cover expected losses 

in ICRAS categories 1–5 in certain cases (see fig. 6). In comparison, using 

fiscal year 2002 expected loss rates, Ex-Im Bank exposure fees at the 

OECD minimum fee level were projected to cover expected losses only for 

ICRAS category 1. 

Figure 6: Comparison of Ex-Im Bank Exposure Feesa and Expected Loss Rates by ICRAS Category, Fiscal Years 2002 and 2005 

Percentage expected loss 

40 

35 

30 

25 

20 

15 

10 

5 

0 

1 2 3 4 5 6 7 8

low risk ICRAS rating high risk 

FY 2002 

FY 2005 

Ex-Im Bank exposure fee based on OECD minimum premia benchmarks 

Sources: GAO analysis of OMB expected loss rates and Ex-Im Bank exposure fee based on OECD minimum premia benchmarks. 

a

Figure compares Ex-Im Bank exposure fees at the minimum OECD fee level with GAO’s analysis of 

expected loss for credits of 8-year maturity in fiscal years 2002 and 2005 (see fig. 4). 

Page 26 GAO-04-531 Export-Import Bank 
The degree to which Ex-Im Bank’s exposure fees are projected to cover its 

expected losses may differ from this illustration, depending on the type of 

borrower or transaction. For example, when Ex-Im Bank assigns a 

corporate borrower a higher risk rating than that of the country where the 

borrower is located, the bank may incur subsidy costs in more risk 

categories or may incur larger subsidy costs for corporate borrowers rated 

in categories 6 through 8.50 This is because Ex-Im Bank charges fees for 

corporate transactions that are close to the OECD minimum fee for the 

country in which the corporate borrower is located, even when the 

transaction has a higher (riskier) rating than the country. In addition, the 

OECD guidance does not apply to some transactions, notably aircraft 

financing. 

In generally setting exposure fees at or near the OECD minimum level, ExIm Bank charges fees that are among the lowest of ECAs. Ex-Im Bank’s low 

pricing relative to other ECAs has been noted for some time. According to 

U.S. and OECD officials, whereas Ex-Im Bank previously appeared to face 

some pressure to charge higher fees because of its budget costs (and 

appeared to support raising the minimum OECD fees as well), the lower 

budgetary costs of Ex-Im Bank’s activities have lessened this pressure.

51 

Ex-Im Bank Modified Its 

Method for Determining 

Financial Statement Loss 

Estimates, Generally Using 

Higher Loss Rates Than for 

Budget Calculations 

Beginning with its 2002 financial statements, Ex-Im Bank modified its 

approach for calculating loss allowances, which involved segmenting its 

portfolio in line with applicable accounting standards and diverging from 

its former practice of using OMB loss rates to calculate these allowances. 

Because Ex-Im Bank prepares its financial statements according to private 

sector, rather than federal, accounting principles, there has always been 

some difference between the bank’s subsidy cost and loss allowance 

estimates. This is because of differences in the treatment of fee income 

50For corporate borrowers that Ex-Im Bank rates as riskier than the OECD sovereign rating 

for the country where the corporation is located, the bank charges fees that are higher than 

the OECD fee by 10 percent increments for each difference in rating level. Thus, if Ex-Im 

Bank rated a corporation in Country A at ICRAS category 5 when Country A is rated at 

ICRAS category 3, the bank would charge that corporation an exposure fee 20 percent 

higher than the OECD fee corresponding to ICRAS category 3. However, because that fee 

would not cover expected loss in ICRAS category 5, Ex-Im Bank would incur subsidy costs 

in this example. 

51A foreign government official noted that Ex-Im Bank exhibits a greater degree of 

transparency than other members of the export credit group by explicitly disclosing the 

subsidy cost of its export credit activities in its budget documents. 

Page 27 GAO-04-531 Export-Import Bank 
between private sector and federal accounting approaches.

52 While Ex-Im 

Bank is not required to use OMB loss rates when calculating financial 

statement loss allowances, Ex-Im Bank officials said that they had 

historically chosen to do so in order to link the loss estimates prepared for 

budget purposes with the financial statement loss allowances. However, in 

its 2002 financial statement, Ex-Im Bank began applying higher loss rates 

than OMB’s loss rates to most of its portfolio. Ex-Im Bank officials said that 

with the modification, its approaches to calculating subsidy costs and loss 

allowances differ not only in fee treatment but also in their expectations of 

loss. 

According to Ex-Im Bank officials, the bank modified its financial 

statement loss allowance methodology for two reasons. First, Ex-Im Bank 

discussed with its new auditors, Deloitte & Touche, the bank’s approach for 

accounting for guarantees and insurance, which comprise a majority of the 

bank’s portfolio.

53 They determined that relevant accounting standards 

suggested that it would be appropriate to record these credits at their fair 

market value. This called for using different loss rates than those derived 

using OMB’s current methodology, which focuses on credit loss.

54 Second, 

the bank determined that it should value its impaired credits in a manner 

more consistent with relevant accounting standards.55 Deloitte & Touche 

observed that Ex-Im Bank had not historically separated its portfolio into 

impaired and unimpaired groupings in accordance with accounting 

guidance, even though a significant portion of these loans and claims were 

likely impaired. Total loans and claims represented, on average, about 24 

percent of the bank’s total exposure during fiscal years 1999-2003. 

In addition, when initially estimating its 2002 loss allowances using its 

former approach and OMB’s fiscal year 2003 loss rates, Ex-Im Bank 

determined that its allowances would have dropped substantially, from 

52Private sector accounting does not recognize future fee income before it is received. In 

contrast, for budget purposes, the present value of future fee income is recognized as an 

offset to expected losses when a loan or guarantee is made. 

532002 was the first year Deloitte & Touche served as Ex-Im Bank's external auditor. 

54FASB Interpretation Number 45 addresses Guarantors’ Accounting and Disclosure 

Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an 

interpretation of FASB Statements Nos. 5, 57, and 107 and rescission of FASB interpretation 

No. 34. 

55Ex-Im Bank officials cited Statement of Financial Accounting Standard 114, which 

addresses Accounting by Creditors for Impairment of Loan. 

Page 28 GAO-04-531 Export-Import Bank 
about $10 billion for 2001 to about $6 billion for 2002, a decrease of about 

40 percent. Because of the size of the reduction and the importance of loss 

allowances as an overall reflection of an institution’s expected loss from 

year to year, the bank’s auditor identified this as a key area to be reviewed. 

Ex-Im Bank’s approach for calculating its loss allowances, beginning with 

the 2002 financial statement, used different loss rate methodologies for 

different parts of its portfolio and distinguished between impaired56 and 

unimpaired credits.

57 To determine the loss allowances for its impaired 

loans and claims and for all of its loan guarantees and medium- and longterm insurance, Ex-Im Bank applied higher loss rates than those that were 

used in 2001. These higher rates were used to calculate about 95 percent of 

the 2002 loss allowance. Ex-Im Bank had asked OMB to provide these 

higher rates using its former, spread-based methodology.

58 Ex-Im Bank 

officials stated that the spread-based loss rates were more appropriate for 

its outstanding guarantees and insurance because they provided a more 

market-based valuation that was better suited to a fair value presentation. 

To determine the 2002 loss allowances for its unimpaired loans and claims, 

Ex-Im Bank applied OMB’s expected loss rates for the fiscal year 2004 

budget.59 These rates were generally lower than the rates used to calculate 

the loss allowance in 2001. For 2002, the bank’s loss allowances were about 

56Ex-Im Bank defined as impaired any loans or claims that are 90 days or more in arrears, 

that are rated in ICRAS categories 9-11, or that have been rescheduled. The bank determined 

that about 34 percent of the loans and about 95 percent of the claims it reported in its 2002 

financial statement were impaired. For fiscal year 2003, about 23 percent of its loans and 95 

percent of its claims were impaired. 

57Ex-Im Bank discloses detailed information about its loss allowance calculation, including 

the different loss rates it uses, in its Annual Portfolio Review, which is compiled by its 

Portfolio Management and Review Division. 

58Ex-Im Bank also applied different loss rates depending on whether the exposures were 

outstanding or undisbursed. To discount the effect of exposure of cancellations and 

suspension of disbursements, Ex-Im Bank set the loss percentage for each ICRAS category 

of undisbursed exposure 15 percent lower than the loss percentage for outstanding 

exposures. 

59Usually, the loss rates that Ex-Im Bank applies to its financial statements are the rates that 

will be in effect in the coming fiscal year. According to an Ex-Im Bank official, fiscal year 

2003 expected loss rates were not used in the 2002 financial statement because OMB made 

the fiscal year 2004 rates available sooner than expected. 

Page 29 GAO-04-531 Export-Import Bank 
6 percent higher than their 2001 level. For 2003, loss allowances were about 

4 percent lower than their 2002 level.60 

Loss Estimation 

Involves Challenges 

and OMB Methodology 

Is Not Transparent 

OMB’s methodology for estimating the expected loss rates for international 

credits provided by U.S. agencies involves challenges, and it is not 

transparent. Assessing the risk of such credit activity, particularly in 

developing countries, is inherently difficult. Corporate default data similar 

to those used by OMB are also used by other financial institutions to assess 

risk, because of the data’s broad coverage and limitations in other data 

sources. However, historically, the data have been based largely on the 

default experiences of U.S. firms, and the data’s historical coverage of 

developing countries has been limited. In addition, more recent Moody’s 

data than were used in estimating OMB’s model show higher defaults in 

some risk categories. In choosing this data to predict default, OMB 

analyzed Ex-Im Bank defaults over a somewhat narrow period. In addition, 

while OMB has assumed increasingly lower recovery rates since 

implementing its method, its basis for the recovery rates and changes in 

them has not been transparent. Finally, despite its complexity and the 

changes it implied, OMB developed the current methodology 

independently and provided ICRAS agencies with limited information 

about the methodology. 

Assessing ECA Financing 

Risk is Difficult, and Data 

Used by OMB May Have 

Inherent Limitations for 

Predicting Ex-Im Bank Risk 

Assessing ECA financing risk presents data challenges. Available indicators 

of default risk, including certain financial institutions’ own financing 

histories, often have limitations. Historical data on corporate bond 

defaults, while used by many institutions, may also have inherent 

limitations for assessing risk in developing countries, because these data 

have historically been based primarily on corporations in higher-income 

countries. In addition, corporate default data now show higher defaults in 

certain higher-risk categories than the data OMB used. OMB’s analysis 

showing comparability between those data and Ex-Im Bank default 

60Ex-Im Bank’s financial statement loss allowances have averaged about 18 percent of its 

total exposure since fiscal year 1999. Ex-Im Bank did not establish any allowances for credit 

losses on its loans and loan guarantees through fiscal year 1988, suggesting that no expected 

losses were associated with any of these credits. As the bank’s independent auditor at this 

time, GAO expressed adverse opinions about the bank’s financial statements for fiscal years 

1983–1988, noting that the financial statements were not fairly presented in accordance with 

GAAP. Ex-Im Bank established financial statement loss allowances for the first time in 1989, 

in the amount of $4.8 billion. 

Page 30 GAO-04-531 Export-Import Bank 
experience was based on Ex-Im Bank credits primarily from a relatively 

narrow period in the 1990s and did not include other ICRAS agencies. OMB 

representatives, in providing oral technical comments on a draft of this 

report, said that they inquired about available default data at other ICRAS 

agencies but were unable to obtain it.

61 OMB’s staff paper noted the 

desirability of adding data from other agencies to its analysis in the future. 

Assessing ECA Financing Risk Is Data limitations and changing environments present challenges for 

Difficult estimating the risk of ECA financing, according to experts and officials 

with whom we spoke. Some noted that ECA risk may differ from private 

bank risk, in that ECAs may be more exposed to emerging markets and 

may have less diversified portfolios, in part because of concentrations of 

exposure to particular industries. Officials said that many ECAs incurred 

large losses during the 1980s debt crisis, and some did so in the 1990s 

during the Asian financial crisis and other instances of sovereign default. 

Moreover, the move among some ECAs, including Ex-Im Bank, toward 

extending more credit to corporate or other nonsovereign borrowers, 

rather than primarily providing financing to sovereign governments, adds 

further complexity to estimating risk. According to several ECA officials, 

corporate activity may involve different risks, which include potentially 

greater difficulty in recovering assets in cases of default. 

Some ECAs and other financial institutions lack data on their own 

financing that are of sufficient historical coverage and reliability for 

predicting the risk of future financing activities. In addition, a lack of risk 

ratings for financing in earlier decades can complicate the use of available 

historical data. Historical data on the default experience of sovereign bond 

issuers might be useful in estimating ECA credit risk, and ratings agencies 

now publish such data. However, according to several experts, the limited 

risk rating history of sovereign bond issuers is a significant limitation to 

relying on this data to assess risk in developing countries. Almost no 

61Assessing the availability of default data at other ICRAS agencies was beyond the scope of 

this review. 

Page 31 GAO-04-531 Export-Import Bank 
developing country sovereign bond issuers have ratings histories that begin 

before the early 1990s.

62 

Corporate Bond Default Data Corporate bond default rates from nationally recognized rating agencies 

Are Widely Used but Lack Broad are widely used by financial institutions in assessing risk but may have 

Historical Coverage of certain inherent limitations for predicting defaults in developing countries. 

Developing Countries	 Institutions use the data because of the large number of firms and long 

historical coverage in the rating agencies’ databases. However, while 

international corporations are now well represented in these data, the data 

historically have included primarily U.S. firms.63 For data with international 

coverage, the coverage has historically been largely of high-income country 

borrowers. One study of a major rating agency database found, for 

example, that 94 percent of the nonbank firms rated were in high-income 

countries, 5 percent were in upper-middle-income countries, and 2 percent 

were in lower-middle-income countries.64 The data’s more limited historical 

coverage of developing country default experiences may limit the 

predictive value of the data for such countries, according to some officials. 

Officials from one institution said that although they used corporate bond 

data in determining expected default rates, whether countries were in 

emerging markets was a consideration in their adjustments of the default 

rates to reflect their own performance expectations. 

62For example, in 1985, Moody’s and Standard & Poor’s rated a total of 15 sovereigns, with 14 

of the countries rated in categories corresponding to ICRAS category 1 and 1 corresponding 

to ICRAS category 5. In 1991, they rated a total of 34 countries, with 21 of the countries rated 

in categories corresponding to ICRAS category 1, 6 rated in categories corresponding to 

ICRAS category 2, and 7 rated in categories corresponding to ICRAS categories below 2. By 

1999, these rating agencies rated a total of 91 countries, with 58 rated in categories below 

those corresponding to ICRAS category 2. (These figures use an average of the two 

agencies’ ratings, in cases where they rated a country differently in a given year.) 

In addition to the limited coverage of ratings, experts have noted that countries historically 

have often given preferential treatment to payments on their bonds compared with their 

loans because bonds represented a relatively small share of a country’s international debt. 

63For example, in 1980, a very small percentage of bond issuers rated by Moody’s were 

located outside the United States; the non-U.S. share grew to about 18 percent by 1990 and 

40 percent by 2000. 

64The study examined Standard & Poor’s data on rated corporations as of 1999. See Giovanni 

Ferri, Li-Gang Liu, and Giovanni Majnoni,“The Role of Rating Agency Assessments in Less 

Developed Countries: Impact of the Proposed Basel Guidelines,” Journal of Banking and 

Finance 25 (2001): 115-148. 

Page 32 GAO-04-531 Export-Import Bank 
More Recent Moody’s Data Show 

Higher Defaults in Some Risk 

Categories 

OMB Used Ex-Im Bank Data 

That Primarily Covered a Limited 

Period to Establish 

Comparability with Corporate 

Data 

More recent Moody’s bond default rates are higher for some higher-risk 

categories than the Moody’s data for 1983-1999 that OMB’s model uses to 

estimate default rates. The more recent data show higher default rates for 

risk levels that correspond to ICRAS categories 7 and 8, the highest risk 

categories in which Ex-Im Bank undertakes new business. For example, for 

fiscal year 2005, OMB’s model predicted a default rate for ICRAS category 

8, assuming a maturity of 8 years, of 41 percent. The Moody’s default rate 

for 1983-1999 was 48 percent, whereas the rate was 52 percent for 1983­

2001, and 58 percent for 1983-2003. Based on our review of available 

information on OMB’s default model, the model would be expected to 

generate higher default rates for these categories if these more current 

Moody’s data were used. 

In deciding to use corporate default data to predict U.S. international credit 

agencies’ defaults, OMB compared data on Ex-Im Bank historical defaults, 

primarily from a limited period, with corporate default rates. Among ICRAS 

agencies, Ex-Im Bank generally extends the largest portion of the U.S. 

government’s new foreign credit exposure each year.

65 OMB did not 

compare other ICRAS agencies’ defaults with the corporate data. OMB 

representatives, in providing oral technical comments on a draft of this 

report, said they inquired at other ICRAS agencies about default data but 

were unable to obtain additional data. OMB recognized in its staff paper the 

value of adding other agencies’ data to its analysis in the future. 

The Ex-Im Bank credits that OMB analyzed were primarily from a relatively 

narrow historical period in the 1990s. OMB examined the default 

probabilities of certain Ex-Im Bank transactions, sorted by risk rating, and 

concluded that Ex-Im Bank default rates were generally somewhat lower 

65Since credit reform, the value of Ex-Im Bank’s annual loans and loan guarantees have been 

the largest among ICRAS agencies, followed by the Commodity Credit Corporation and the 

Overseas Private Investment Corporation. On a total exposure basis, at the end of fiscal year 

2002, Ex-Im Bank represented 40 percent of the U.S. government’s credit exposure to 

sovereign and other official foreign borrowers; the Agency for International Development 

and the Departments of Agriculture and Defense represented most of the remainder. At that 

time, Ex-Im Bank also represented about 70 percent of the U.S. government’s credit 

exposure to private foreign borrowers, with the remainder held primarily by the Overseas 

Investment Protection Corporation and the Department of Agriculture. 

Page 33 GAO-04-531 Export-Import Bank 
than those of corporate bonds across comparable rating categories.66 

However, a comparison based primarily on lending activity over a relatively 

short time frame may not be representative of Ex-Im Bank’s overall default 

risk. In addition, according to several experts and officials, data that 

reflected only the international business climate of the 1990s would not be 

representative of the risk of international lending. 

For this comparison, OMB used data from an Ex-Im Bank database 

covering guarantees and medium-term insurance transactions from fiscal 

years 1985-1999. This data set did not include loans, which comprised a 

significant part of Ex-Im Bank financing through the early 1980s, and which 

experienced substantial defaults during an international debt crisis that 

began in the early 1980s.

67 While we could not determine the specific data 

that OMB analyzed,68 our analysis of the 1985-1999 database indicated that 

the majority of observations in the overall database, and a strong majority 

66OMB initially calculated default probabilities directly for different risk categories. Because 

of the relatively small number of observations in the database, the patterns shown were 

somewhat erratic, with higher percentages of defaults in some lower-risk categories than in 

higher-risk categories. OMB then used a statistical model to smooth the patterns of 

historical defaults across ratings categories for ICRAS categories 1-6. 

67According to Ex-Im Bank officials, in 2000, they provided OMB a database of the bank’s 

guarantees and medium- and long-term insurance financing activities covering fiscal years 

1985-1999, which Ex-Im Bank had created to provide information to a private bank with 

which they were considering joint financing. According to Ex-Im Bank officials, they did not 

include loans in the creation of that data set in 1999 because loans had become less 

important in the bank’s financing. Ex-Im Bank officials told us that the reliability of this data 

is considerably greater for transactions initiated in 1996 or later. Beginning in 1996, the key 

component databases were updated to increase automatic data entry and verification. 

68In a written response to our questions, OMB provided information indicating that its 

analysis was based on data from 1993 and later, but OMB staff stated subsequently that the 

analysis had used all observations in the data set. Within the data set, credits prior to fiscal 

year 1992 lack ICRAS risk ratings. OMB staff stated that they assigned ratings by using risk 

ratings from private rating agencies. However, we determined that very few countries below 

the highest rating categories were rated by private rating agencies before 1992. This is 

discussed in footnote 62. 

Page 34 GAO-04-531 Export-Import Bank 
of observations for which risk ratings were available, were from the mid- to 

late-1990s.69 

Recovery Rate Assumptions 

Have Not Been Transparent 

The basis for OMB’s recovery rate assumptions and the changes over time 

has not been transparent. During our audit work, OMB did not respond to 

questions about the specific basis for its recovery rate assumptions of 17 

and 12 percent, respectively, for fiscal years 2003-2004. OMB further 

reduced assumed recovery rates to 9 percent for fiscal year 2005. In 

discussing recovery rate assumptions during the audit work, OMB cited its 

staff paper, which contained a recovery rate of 20 percent that OMB said 

was based generally on the ratio of aggregate recoveries to aggregate 

claims in Ex-Im Bank historical data. However, in discussions on a draft of 

this report, OMB representatives said that the market price of credits with 

the lowest ICRAS rating (category 11) was the predominant basis for 

recovery rates, although they did initially also consider data on Ex-Im Bank 

recoveries. OMB representatives said using the market price of the lowestrated credits is based on the assumption that this value represents the most 

the U.S. government would recover in the event of a default. They provided 

information to show that changes in OMB’s calculation of market prices of 

these credits accounted for drops in the recovery rate assumptions over 

time.

70 Changes in OMB’s calculation of these prices resulted in part from 

technical comments by Treasury officials. 

Our analysis of the 1985-1999 Ex-Im Bank data indicates that the ratio of 

aggregate recoveries to aggregate claims in that database is about 19 

69We obtained the 1985-1999 data set from Ex-Im Bank and examined the distribution of 

transactions across the period covered. We determined that, depending on how one defines 

the unit of analysis, from two-thirds to over three-fourths of the observations in the data set 

for which Moody’s Investors Service, Standard & Poor’s, or ICRAS country ratings were 

available were from 1994-1999. We also determined that, irrespective of which observations 

had ratings associated with them, between slightly more than half and two-thirds of them 

were from 1994 or later. Between 85 and 91 percent of all the observations in the database 

were from 1990 or later. 

70Footnote 33 provides more information on how OMB uses market prices in calculating 

expected losses for ICRAS categories 9-11. 

Page 35 GAO-04-531 Export-Import Bank 
percent.

71 Recovery rates that were based on aggregate data over a limited 

time period would tend to underrepresent actual recoveries because of the 

limited period for recoveries to be observed, especially those associated 

with defaults occurring at the end of the period. 

According to financial institution officials and rating agency analysis, 

recovery rates tend to vary by borrower type and risk and can fluctuate 

cyclically. OMB’s recovery rates assumptions appear to be conservative 

compared with recovery rates assumed by other financial institutions. 

Institutions we talked to generally assumed higher recovery rates than 

OMB, and some tailored their recovery rate assumptions according to the 

type of borrower. According to rating agency analysis, recovery rates are 

generally lower for riskier credits and fall during periods when defaults are 

higher. 

If recovery rates assumed by OMB are lower than likely Ex-Im Bank 

recoveries, they will offset, to some degree, lower expected defaults in the 

calculation of expected losses. Because expected losses are calculated by 

combining expected default and expected recovery rates, an unrealistically 

low recovery rate would necessarily offset an unrealistically low expected 

default rate, within certain ranges.

72 

71We analyzed the Ex-Im Bank data sets primarily at the aggregate level. Recovery amounts 

in this data set represent recoveries received directly by Ex-Im Bank and do not include 

payments to the U.S. government through reschedulings of sovereign credits. Ex-Im Bank 

provided us a second data set that updated the 1985-1999 data through fiscal year 2001. Our 

analysis showed that the ratio of aggregate recoveries to aggregate claims in the second data 

set is about 35 percent. Ex-Im Bank officials said that, when recoveries through 

reschedulings are included, their total recovery rates are higher. Our analysis showed that, 

when recoveries through reschedulings are included, total recovery rates were about 26 

percent for 1985-1999 period and about 43 percent for the 1985-2001 period. 

72For example, in a hypothetical situation where the true default probability was known to 

be 20 percent and the true recovery rate was 30 percent (corresponding to a loss rate of 70 

percent), the true expected loss rate would be 14.0 percent (20 x .70=14.0). However, an 

overly low default rate of 15 percent combined with an overly low recovery rate of 10 

percent (corresponding to a loss rate of 90 percent) would yield a similar expected loss rate, 

13.5 percent (15 x .90=13.5). 

Page 36 GAO-04-531 Export-Import Bank 
OMB Developed Method 

Independently and Provided 

Agencies Limited 

Information 

Because of OMB’s unique role in developing the loss rates that ICRAS 

agencies use to calculate subsidy costs, these agencies rely on OMB to 

comply with credit reform requirements that address the agencies’ 

responsibilities for assuring the reliability of their subsidy cost estimates. 

Despite the complexity of the current methodology and its implications for 

ICRAS agencies’ subsidy costs, OMB developed the current methodology 

predominantly on its own, receiving some input from one ICRAS agency. 

Some ICRAS officials said that OMB provided agencies with limited 

information about the methodology’s basis or structure. 

Credit reform guidance on developing credit subsidy estimates addresses 

the procedures and internal controls that agencies should have in place to 

ensure that their estimates are reliable.73 It states that any changes in 

factors and key assumptions, such as default and recovery rates, should be 

fully explained, supported, and documented. The purpose of thorough 

documentation is to enable independent parties to perform the same steps 

and replicate the same results with little or no outside explanation or 

assistance. 

OMB representatives said that the current methodology was reviewed 

within OMB and circulated among the ICRAS agencies, although several 

ICRAS agency officials told us OMB had provided them limited 

information. According to these officials, OMB presented its methodology 

as an essentially completed approach and held several meetings during 

2001 and early 2002 to discuss it. Officials who received information and 

attended certain meetings told us that it was difficult to understand or 

evaluate the methodology based on the information provided. For example, 

prior to one meeting, OMB circulated a two-page discussion paper that 

discussed OMB’s rationale for adopting the current methodology and 

generally described its approach and a technical appendix to a staff paper 

that contained numerous equations describing a theoretical model. 

73Federal Accounting Standards Advisory Board, Federal Financial Accounting and 

Auditing Technical Release 6—Preparing Estimates for Direct Loan and Loan Guarantee 

Subsidies under the Federal Credit Reform Act, Amendments to Technical Release 3: 

Preparing and Auditing Direct Loan and Loan Guarantee Subsidies Under the Federal 

Credit Reform Act (Washington, D.C.: January 2004). This guidance was developed by the 

Accounting and Auditing Policy Committee, a permanent committee of the Federal 

Accounting Standards Advisory Board. The committee was organized by OMB, GAO, the 

Department of Treasury, the Chief Financial Officers’ Council, and the President’s Council 

on Integrity and Efficiency as a body to research accounting and auditing issues requiring 

guidance. 

Page 37 GAO-04-531 Export-Import Bank 
However, OMB representatives told us that some of the equations in this 

appendix were not actually used in the methodology while other equations 

not contained in the appendix were used. At one meeting, according to a 

Department of Agriculture economist, OMB provided only the expected 

loss rates for fiscal year 2003 and a graph that predicted a decline in Ex-Im 

Bank subsidy rates. This official said it was not possible to understand the 

methodology by only examining its results. She said that although she and 

other ICRAS agencies representatives posed various questions about the 

method’s underlying data and assumptions, OMB representatives did not 

provide substantive responses and stated that the method was too complex 

to explain. OMB representatives said the methodology was not reviewed 

outside the U.S. government. 

After presenting the methodology, OMB received comments on the 

methodology from at least one ICRAS agency. Treasury officials told us that 

when they examined the proposed expected loss rates for fiscal year 2003, 

they objected to the substantially lower loss rates for the riskiest countries, 

those in ICRAS categories 9 through 11; asked to see the underlying data 

used; and raised methodological issues regarding how those rates were 

calculated.74 The Treasury officials said that while they had some questions 

about the expected loss rates for other ICRAS categories, they focused 

their attention on the treatment of the riskiest countries. The reason, they 

said, was that planned drops in expected loss estimates for these countries 

would sharply increase the cost to the United States of forgiving existing 

debt, such as through international agreements to forgive the debt of highly 

indebted poor countries.

75 According to Treasury officials, OMB revised its 

approach for estimating expected losses in ICRAS categories 9 through 11, 

which resulted in loss rates that were not significantly changed from those 

in effect before fiscal year 2003. 

We found that some financial institutions used outside experts or 

consultants in developing their loss estimation methodologies. Some also 

described procedures that exist to ensure their methodology’s ongoing 

objectivity and reliability. For example, other government agencies, audit 

74Treasury officials determined, for example, that some credits that were being used to 

determine the market value and implicitly the riskiness of lower-rated country data were 

backed with collateral, which would be expected to result in lower risk and higher prices. 

75When the U.S. government forgives a country’s debt, the budgetary cost of the debt relief is 

determined by the estimated value of the debt under credit reform terms. Thus, the lower 

the estimated value of the debt, the lower the budgetary cost of debt forgiveness. 

Page 38 GAO-04-531 Export-Import Bank 
organizations, and outside experts have been involved in developing or 

reviewing the methodologies of two foreign ECAs that we contacted. Also, 

regulatory bodies, audit organizations, and internal risk management 

groups are involved in overseeing bank loss estimation methodologies. 

Conclusions	 In passing the Federal Credit Reform Act in 1990, Congress required 

agencies to develop reasonable estimates about the long-term cost to the 

government of federal credit programs, to ensure a sound basis for 

decisions regarding program budgets. For international credit agencies 

such as Ex-Im Bank, which finances activities in relatively risky markets, 

predicting long-term costs and determining appropriate budget subsidy 

amounts is especially challenging. Because of the importance of reasonable 

program cost estimates under credit reform, such estimates need to be 

made with appropriate data and using appropriate analytical techniques. 

While ICRAS agency subsidy costs have several determinants, including the 

particular risk ratings assigned to different borrowers, OMB’s directions to 

ICRAS agencies regarding loss rates across risk levels are an important 

element of estimating subsidy costs. 

OMB’s shift to using historical corporate default data in its methodology for 

estimating loss rates of ICRAS agency activities has some basis, given the 

practices of other financial institutions and limitations in available 

historical data. However, the predictive value of those corporate default 

data for the financing undertaken by Ex-Im Bank or other ICRAS agencies 

has not yet been established. Obtaining additional information on agencies’ 

default and repayment experiences over time will allow better assessments 

of the suitability of using data such as corporate bond default rates. 

The lack of transparency of OMB’s current loss rate methodology raises 

questions about how it determines expected loss rates. Because of this lack 

of transparency, combined with the method’s complexity, the multiple 

ICRAS agencies that use the loss rates have incomplete information about 

how those rates are determined and what factors are driving changes over 

time. OMB’s unique role in setting ICRAS agency loss rates suggests that 

greater transparency would be appropriate. In addition, other credit reform 

tools that multiple credit agencies use to calculate subsidy costs, such as 

OMB’s credit subsidy calculator, have been audited to assure users about 

their accuracy. Independent review of OMB’s methodology would provide 

similar assurance about the reliability of the loss rates and the subsidy 

costs developed from these rates, and could help facilitate ICRAS agency 

financial statement audits. 

Page 39 GAO-04-531 Export-Import Bank 
Recommendations for 

Executive Action 

To improve the transparency of the subsidy cost estimation process and 

help ensure the validity of estimates over time, we recommend that the 

Director of the Office of Management and Budget take the following five 

actions: 

•	 Provide ICRAS 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. 

•	 Provide similar information in the event of significant changes in its 

method of calculating expected loss rates. 

•	 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. 

•	 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. 

•	 Arrange for independent methodological review of OMB’s expected loss 

rate model and assumptions and document that review. 

Agency Comments and 

Our Evaluation 

We provided a draft of this report for formal comment to the Director, 

Office of Management and Budget; the Chairman, Export-Import Bank; the 

Secretary of the Treasury; the Chairman, Board of Governors of the Federal 

Reserve System; the Comptroller of the Currency; and the Chairman, 

Federal Deposit Insurance Corporation. We also provided a copy of the 

draft report for technical review to the Chairman, Securities and Exchange 

Commission, and officials at the Foreign Agricultural Service of the 

Department of Agriculture. OMB provided written comments on the draft 

report, which are reprinted in appendix IX. OMB, Ex-Im Bank, the 

Comptroller of the Currency, and the Securities and Exchange Commission 

provided technical comments, which we incorporated as appropriate. 

Other agencies reviewed the report but had no comments. We also 

obtained technical comments from bank and foreign ECA officials on our 

descriptions of their practices. 

Page 40 GAO-04-531 Export-Import Bank 
OMB generally agreed to implement the report’s recommendations to make 

more information available on its expected loss methodology, update the 

nonagency data used in the model, obtain additional agency default data 

over time, and obtain technical review. OMB also expressed concern about 

the report’s statement that OMB’s method for determining loss rates was 

not transparent, observing that our report generally describes the method. 

We believe that, while we do present in this report a substantial amount of 

information on OMB’s loss methodology, obtaining that information 

required considerable resources and effort with certain information 

provided only during the agency comment period despite repeated 

inquiries by GAO, and that similar information should be more readily 

available to affected agencies and Congress on an ongoing basis. 

We are sending copies of this report to appropriate Congressional 


Committees. We are also sending copies of this report to the Director, 


Office of Management and Budget; the Chairman, Export-Import Bank; the


Secretary of the Treasury; the Chairman, Board of Governors of the Federal 


Reserve System; the Comptroller of the Currency; the Chairman, Federal 


Deposit Insurance Corporation; the Chairman, Securities and Exchange 


Commission; and the Administrator, Foreign Agricultural Service of the 


Department of Agriculture. We also will make copies available to others 


upon request. In addition, the report will be available at no charge on the 


GAO Web site at http://www.gao.gov.


If you or your staff have any questions about this report, please contact me 


on (202) 512-4346. Additional GAO contacts and staff acknowledgments are 


listed in appendix X.


Loren Yager, Director


International Affairs and Trade Issues


Page 41 GAO-04-531 Export-Import Bank 
Appendix I 

Objectives, Scope, and Methodology


The Export-Import Bank Reauthorization Act of 2002 directed GAO to 

report to the House of Representatives Committee on Financial Services 

and the Senate Committee on Banking, Housing and Urban Affairs on the 

reserve practices of the Export-Import Bank (Ex-Im Bank) as compared 

with the reserve practices of private banks and foreign export credit 

agencies (ECA). The committees were specifically interested in Ex-Im 

Bank’s method for estimating the subsidy costs of its financial activities for 

budgetary purposes in accordance with the Federal Credit Reform Act of 

1990. Ex-Im Bank subsidy costs are determined, in part, on the basis of a 

methodology established by the Office of Management and Budget (OMB); 

OMB’s methodology changed substantially in fiscal year 2003. 

In response to the mandate, we agreed to (1) describe OMB’s current and 

former methodologies for estimating expected loss rates for international 

credits and the rationale for the recent revisions, (2) determine the impacts 

of the current OMB methodology on Ex-Im Bank, and (3) assess the current 

methodology and the process by which it was developed. We also agreed to 

provide information on the reserve practices of foreign ECAs and 

commercial banks. 

To describe OMB’s current and former methodologies for estimating 

expected loss rates for U.S. credit agencies’ international credit and the 

rationale for the recent revisions, we reviewed OMB descriptions of the 

methodologies and discussed the rationale for the changes to the 

methodology with OMB staff and Ex-Im Bank, Treasury, and Congressional 

Budget Office officials. We also reviewed finance literature that OMB cited 

as a basis for modifying its approach, as well as related literature, and 

examined Ex-Im Bank information about trends in its subsidy cost 

reestimates (discussed later). Our description of the former methodology is 

also based on prior GAO work, on OMB memoranda to agencies that 

participate in the Interagency Country Risk Assessment System (ICRAS) 

announcing the risk premiums or expected loss rates to be used in 

preparing budget estimates for upcoming fiscal years, and on our analysis 

of expected loss rates for fiscal years 1997-2002, as described later. We 

generally describe how ICRAS risk ratings are established and how Ex-Im 

Bank rates private borrowers, and while we recognize that the assignment 

of risk ratings is an important element in the overall reasonableness of 

expected loss estimates, evaluating the reasonableness of the risk ratings 

process and of specific ratings was beyond this scope of this engagement. 

To describe the current methodology, we examined OMB’s written 

descriptions of its methodology, posed specific questions to OMB staff on 

Page 42 GAO-04-531 Export-Import Bank 
Appendix I


Objectives, Scope, and Methodology


several occasions through their Office of General Counsel, and held some 

discussions with OMB staff about the methodology. The information and 

documentation we obtained enabled us to generally understand and 

describe the methodology and the underlying data, but did not explain all 

aspects of the methodology or the specific reasons for certain results. We 

note in the report where our description of certain aspects of the 

methodology is incomplete. However, these areas were not material to our 

conclusions. 

The primary documentation we initially reviewed, an OMB paper entitled 

“Proposal for modification of the ICRAS system,” describes (1) OMB’s 

rationale for adopting its new methodology, (2) analysis OMB performed in 

developing the methodology, and (3) certain assumptions and equations 

that describe a general theoretical model.

1

 However, because the paper 

describes a theoretical model and includes limited information on specific 

analyses performed, data used, key assumptions, and results, and because 

not all of the elements of the model described in the paper were used by 

OMB, we required additional information from OMB. To obtain additional 

information from OMB, we were required to submit written questions to an 

attorney in OMB’s Office of General Counsel for transmission to OMB 

technical staff. The attorney also reviewed the responses that the technical 

staff prepared before they were provided to GAO. OMB staff provided a 

combination of oral and written responses to our initial set of questions, 

but because we still lacked important information, we sought additional 

clarification from OMB. At OMB’s request, we provided OMB staff with a 

Statement of Fact that (1) described our understanding of OMB’s expected 

loss methodology based on information provided to that point and (2) 

identified remaining questions. We met again with the OMB attorney and 

technical staff, who responded to our questions. We requested an 

electronic version of the methodology, which OMB did not agree to 

provide. We attempted to further clarify certain issues, but OMB provided 

limited responses. OMB representatives provided certain additional 

technical information in comments on a draft of this report. 

To determine the estimated default probabilities generated by the default 

component of OMB’s methodology for fiscal years 2004 and 2005, we 

adjusted the expected loss rates for each rating and maturity category that 

1

The paper that OMB provided was marked “Draft: For Discussion Purposes Only,” but OMB 

representatives told us there were no subsequent versions and it should be considered a 

final paper. 

Page 43 GAO-04-531 Export-Import Bank 
Appendix I


Objectives, Scope, and Methodology


OMB provided to ICRAS agencies by dividing each rate by one minus the 

recovery rate OMB assumed for each year. We confirmed that process with 

OMB. To determine the extent to which the default probabilities estimated 

by OMB’s default model differed from the rating agency corporate default 

rates used as inputs to the model, we statistically compared the model’s 

outputs for fiscal year 2004 and 2005 with the corporate default rates used. 

We also determined the current methodology’s output in terms of expected 

loss rates across the ICRAS risk categories. To do so, we obtained 

electronic copies of Ex-Im Bank’s cash flow spreadsheets for guarantees as 

well as copies of the OMB Credit Subsidy Calculator, which converts 

agency cash-flow payments into present value terms. To isolate the default 

or expected loss component of Ex-Im Bank subsidy costs from other 

components (including fees and interest rate subsidies), we entered 

consistent information into the Ex-Im Bank cash flow worksheets for each 

ICRAS risk category for fiscal years 2002 through 2005 and conducted this 

analysis for 5-year, 8-year, and 10-year credits. We conducted similar 

analysis for 8-year credits for fiscal years 1997 through 2002. We 

determined the present value of the results, based on a constant discount 

rate, using OMB’s credit subsidy calculator. We discussed our analysis with 

Ex-Im Bank officials, who generally confirmed our approach and output. 

To determine the impacts of the current OMB methodology on Ex-Im Bank, 

we examined changes in the components of Ex-Im Bank’s subsidy costs 

and financial statement loss allowances. Specifically, we examined the 

following: 

•	 To determine the effect of the current methodology on Ex-Im Bank’s 

budget needs, we reviewed Ex-Im Bank budget information from fiscal 

years 1992-2005 and analyzed changes in the bank’s requests for subsidy 

cost authorization and its obligation of budget authority for subsidy 

costs over that time period. We also interviewed Ex-Im Bank officials 

regarding their views on how changes in expected loss rates affected the 

bank’s subsidy costs. We determined that Ex-Im Bank’s budget 

information was sufficiently reliable for the purpose of documenting the 

bank’s changing budget needs and confirmed our analyses with Ex-Im 

Bank officials. We also examined Ex-Im Bank information, contained in 

internal documents, on its reestimate calculations for fiscal years 1992­

1995 and 1999-2003 and interviewed Ex-Im Bank officials regarding their 

views on how changes in expected loss rates affected the bank’s 

reestimates. Ex-Im Bank’s internal reestimate information differed 

slightly in some years from information contained in the Federal Credit 

Page 44 GAO-04-531 Export-Import Bank 
Appendix I


Objectives, Scope, and Methodology


Supplement about the bank’s reestimates. Both sources of information 

portrayed similar overall trends, but the Ex-Im Bank internal 

information covered a longer period of time than the credit supplement 

information. We also discussed with Ex-Im Bank officials the bank’s 

process for calculating reestimates, and we examined auditor 

workpapers for the 2002 audit of Ex-Im Bank’s financial statement, in 

which the auditors examined and verified the bank’s reestimate for 

fiscal year 2002. Thus, we determined that the Ex-Im Bank information 

was sufficiently reliable for the purpose of showing trends in the bank’s 

reestimates since the start of credit reform, as well as the magnitude of 

the bank’s reestimates following the implementation of OMB’s current 

methodology. 

•	 To determine the impact of the current methodology on the changing 

relationship between Ex-Im Bank’s projection of expected losses and its 

fee income, we compared our analysis of expected loss rates for fiscal 

years 2002-2005 with the minimum fees that Ex-Im Bank can charge 

under an agreement among participating Organization for Economic 

Cooperation and Development’s (OECD) member countries. We 

determined these fees using Ex-Im Bank’s Exposure Fee Calculator, 

available on its Internet site. Ex-Im Bank officials confirmed our 

analysis. To identify how the relationships between expected losses and 

fee income could be different for corporate borrowers, we identified the 

way that corporate ratings are assigned and fees determined, based on 

interviews with Ex-Im Bank officials and on fee information from Ex-Im 

Bank’s Internet site. 

•	 To determine the impact of the current methodology on Ex-Im Bank’s 

financial statement loss allowances, we reviewed Ex-Im Bank’s audited 

financial statements for fiscal years 2002 and 2003 and the auditor’s 

workpapers supporting its audit of the 2002 financial statement. We 

determined that the data in the audited financial statements were 

reliable for the purposes of our analysis. We discussed the modification 

in Ex-Im Bank’s methodology for calculating financial statement loss 

allowances, including the impact of the current methodology’s lower 

loss rates in calculating those loss allowances, with officials from Ex-Im 

Bank and its auditor, Deloitte Touche. 

To assess the current methodology and the process by which it was 

developed, we identified and evaluated the basis for key OMB assumptions, 

methodological components, and data used. We also examined OMB 

documentation of the process and discussed the process with 

Page 45 GAO-04-531 Export-Import Bank 
Appendix I


Objectives, Scope, and Methodology


representatives from OMB, Ex-Im Bank, Treasury, and certain other 

agencies that participate in the ICRAS process. We did not replicate or 

validate the methodology because we lacked complete documentation and 

did not have access to the computer programs that were used to estimate 

OMB’s default model. We also did not determine the reasonableness of 

specific loss rates that OMB has estimated. 

To assess the methodology, we interviewed cognizant U.S. and foreign 

officials and experts and reviewed relevant studies. For example, we 

discussed loss estimation methodologies with credit experts and officials 

from certain financial institutions, including commercial banks, foreign 

export credit agencies, and other foreign officials. On the basis of these 

discussions and this review, we identified challenges, concerns, and 

practices, such as potential limitations in using certain data for projecting 

future defaults and the degree to which institutions followed similar or 

different practices in estimating default and loss. 

To determine whether the corporate bond default rates used in OMB’s 

default model have varied significantly since the model was created, we 

compared the specific Moody’s Investors Service corporate bond default 

rates used in OMB’s analysis with updated published versions of those 

Moody’s rates. 

We obtained information from OMB regarding its comparison of Ex-Im 

Bank default rates to the corporate default data used in its model, and we 

obtained from Ex-Im Bank the historical data sets that Ex-Im Bank said it 

gave OMB. We obtained certain information from OMB about how it 

analyzed the Ex-Im Bank data, and while we were able to determine the 

time period primarily covered by this analysis, we were not able to 

determine the specific data that OMB analyzed because we were unable to 

reconcile certain information that OMB provided. In assessing the time 

period covered by OMB’s analysis, we obtained historical country ratings 

data from Moody’s and Standard & Poor’s documents and historical ICRAS 

ratings information from Ex-Im Bank. We used these to determine the 

proportion of observations in the Ex-Im Bank data sets for which risk 

ratings at the time of the transaction were available. 

We examined OMB’s assumptions about recovery rates and compared 

these with aggregate recovery rates that we calculated on Ex-Im Bank 

datasets covering guarantees and some insurance for 1985-1999 and 1985­

2001, as well as with recovery rate assumptions made by other financial 

institutions. We discussed the reliability of the Ex-Im Bank data sets and of 

Page 46 GAO-04-531 Export-Import Bank 
Appendix I


Objectives, Scope, and Methodology


the underlying systems used to create the data with Ex-Im Bank officials, 

who said they view the data they have compiled to be a reasonable 

representation of their historical experiences and adequate for its intended 

purposes, which were initially to provide information about Ex-Im Bank’s 

activities to a potential private sector partner. The officials stated that the 

reliability of data about individual transactions is considerably greater for 

transactions initiated in 1996 and later because of changes that improved 

data entry and verification. We determined the data were sufficiently 

reliable for our purpose of comparing aggregate recovery rate information 

in the datasets with the recovery rate assumptions used by OMB. 

To broadly assess the technical features of OMB’s default model, we 

evaluated information provided by OMB that described the model’s 

equations and how they were estimated, based on standard econometric 

criteria. We did not conduct a complete technical review because we did 

not have access to full documentation of the model or the model in 

electronic format. 

To assess the process by which the current methodology was developed, 

we discussed with OMB representatives and certain other ICRAS officials 

the respective agencies’ role and degree of involvement in developing and 

providing comment on the methodology. We also reviewed documents that 

OMB had distributed to ICRAS agencies about its methodology and 

discussed with ICRAS officials the general time frames in which the 

methodology was developed and the nature of certain meetings that OMB 

held to present information about its methodology. The ICRAS officials we 

interviewed received information about the methodology’s development 

and implementation and have had continuing participation in the ICRAS 

process. We also reviewed credit reform guidance on preparing and 

auditing subsidy costs.2 

2

Federal Accounting Standards Advisory Board, Federal Financial Accounting and 

Auditing Technical Release 6—Preparing Estimates for Direct Loan and Loan Guarantee 

Subsidies under the Federal Credit Reform Act, Amendments to Technical Release 3: 

Preparing and Auditing Direct Loan and Loan Guarantee Subsidies Under the Federal 

Credit Reform Act (Washington, D.C.: January 2004). This guidance was developed by the 

Accounting and Auditing Policy Committee, a permanent committee of the Federal 

Accounting Standards Advisory Board. The committee was organized by OMB, GAO, the 

Department of the Treasury, the Chief Financial Officers’ Council, and the President’s 

Council on Integrity and Efficiency, to research accounting and auditing issues requiring 

guidance. 

Page 47 GAO-04-531 Export-Import Bank 
Appendix I


Objectives, Scope, and Methodology


To provide information on the reserve practices of foreign ECAs, we 

judgmentally selected a sample of four ECAs that are key competitors of 

Ex-Im Bank or that were identified by knowledgeable U.S. and private 

sector officials as entities that had examined or changed their reserve 

practices in recent years. These included Compagnie Française 

d’Assurance pour le Commerce Extérieur in France, Euler Hermes 

Kreditversicherungs-Aktiengesellschaft in Germany, the Export Credits 

Guarantee Department in the United Kingdom, and Export Development 

Canada. In each case, we discussed with officials, and reviewed available 

documentation on, the ECA’s statutory mandate, financial activities, and 

reserve practices. We also reviewed public financial statements where 

available. We also met with officials from other government organizations 

in these countries, including treasury or finance ministries. We met with 

officials from the Office of the Auditor General of Canada, France’s Cours 

des Comptes, and the U.K.’s National Audit Office, because those offices 

audit the financial statements of the Canadian, French, and U.K. ECAs, 

respectively. We obtained the perspectives of officials from ECAs and other 

government agencies on the difficulties associated with developing loss 

estimation methodologies and using available data. In addition, we 

discussed these issues with an official from the export credit group of the 

OECD, and officials at the Office National du Ducroire/Nationale 

Delcrededienst in Belgium, including the chair of a group of OECD export 

credit country risk experts. 

To provide information on the reserve, or loan loss allowance, practices of 

commercial banks, we judgmentally selected a sample of three U.S. 

commercial banks with large lending portfolios totaling approximately 

$800 billion, including large international exposures. For each bank, we 

spoke with management involved in international lending and the 

calculation of the bank’s loan loss allowance. In addition, we reviewed the 

banks’ financial statements and any documentation that was provided. We 

also met with several U.S. banking regulators—the Federal Reserve Board, 

Office of the Comptroller of the Currency, and the Federal Deposit 

Insurance Corporation—to discuss the loan loss allowance guidance banks 

are required to follow. We reviewed both regulatory and accounting 

guidance governing the calculation of the loan loss allowance by 

commercial banks. 

Page 48 GAO-04-531 Export-Import Bank 
Appendix II 

Loss Estimation Practices of Foreign Export 

Credit Agencies 

Significant variation exists among the loss estimation, or reserve, practices 

of foreign export credit agencies (ECA) that we consulted.1

 Differences in 

mission, structure, and accounting approaches help explain this variation. 

Some of these ECAs are expected to avoid competing with private sector 

financial institutions, which may result in more exposure to emerging 

market borrowers and riskier portfolios as compared with other ECAs. 

These ECAs’ financial relationships with their governments differed, as did 

their individual responsibility for covering any losses that might result from 

their activities. Some ECAs follow an accounting approach that prescribes 

estimating probable losses over time, while others follow an accounting 

approach that precludes such estimation. ECAs in Canada and the United 

Kingdom (U.K.) have recently adopted or plan to implement new 

methodologies for estimating the likelihood of default and loss associated 

with their activities. ECAs in France and Germany follow a simpler 

approach in which the fees they collect on a given transaction, in 

accordance with an international agreement among export credit agencies, 

are regarded as sufficient to cover any likely losses on the transaction. The 

French ECA is studying a new accounting system that would enable it to 

more closely align its loss expectations with its historical repayment 

experiences. (App. I contains information about our objectives, scope, and 

methodology for examining the reserve practices of foreign ECAs.) 

ECAs in Canada and 

the United Kingdom 

Have Methodologies to 

Estimate Future 

Defaults and Losses in 

Determining Reserve 

Levels 

ECAs in Canada and the United Kingdom determine their required level of 

loss reserves by estimating the extent of probable losses in their portfolio 

at a point in time, some of which may result from future defaults. These 

ECAs’ missions, structures, and accounting approaches lend important 

context to their reserve practices. The Canadian and U.K. ECAs have 

recently revised (or are in the process of revising) their risk assessment 

and reserve practices to more precisely measure future losses. In 

developing their approaches, these two ECAs examined the risk 

assessment and reserve practices of leading financial institutions and 

worked with private sector risk assessment specialists. Their approaches 

1

We discussed reserve practices with Export Development Canada, Compagnie Française 

d’Assurance pour le Commerce Extérieur in France, Euler Hermes Kreditversicherungs-AG 

in Germany, the Export Credits Guarantee Department in the United Kingdom, and the 

Office National du Ducroire/Nationale Delcrederedienst in Belgium. For ease of reference, 

we do not use these entities’ proper names in this appendix. We recognize that “reserves” is 

not a technical term, but we use it in this appendix because each ECA used different 

terminology to refer to its practices. 

Page 49 GAO-04-531 Export-Import Bank 
Appendix II


Loss Estimation Practices of Foreign Export


Credit Agencies


have similar elements but differ in important respects. The new approaches 

have been reviewed by specialists outside the ECA. 

Mission, Structure, and 

Accounting Approaches 

Affect Reserve Practices 

The Canadian and U.K. ECAs’ mission is to help facilitate national exports, 

but their particular methods and structure for doing so differ. The Canadian 

ECA is a wholly owned government corporation that was capitalized with 

funds from the Canadian government and operates with the full faith and 

credit of the Canadian government. According to officials of this ECA, the 

entity is self-sustaining, in that it does not receive annual infusions of 

budgetary support for its operations or losses. Its largest business activity 

in terms of volume is short-term export insurance, but it also offers loans 

and medium-term insurance and loan guarantees. According to the 

Canadian ECA, it takes a commercial approach to managing its risks to 

ensure its long-term financial health. This institution makes its own 

decisions about the credits it will offer and is not prohibited from 

competing with private sector financial institutions.

2

 Long-term 

transactions that it determines are beyond its risk capacity and are 

inconsistent with its long-term health may be referred to the government of 

Canada for consideration. The Canadian government may accept and 

manage those risks provided that there is sufficient national benefit to 

Canada.3 

In contrast, the U.K. ECA is a government department that receives annual 

budgetary support (subject to Parliamentary approval) to help fund its 

operations and cover its losses. The U.K. ECA is in a time of transition. The 

ECA’s operations were streamlined in 1991, when new legislative authority 

required it to sell its short-term insurance business and focus on mediumand long-term project finance.4 The U.K. ECA is expected to avoid direct 

competition with U.K. private insurers and banks. It is also expected to 

undertake and manage its activities to ensure, with a high degree of 

2

The majority of business the Canadian ECA undertakes annually is transacted in what it 

calls its Corporate Account. 

3

These are known as Canada Account transactions and are undertaken infrequently. The 

Canadian ECA executes the transaction on behalf of the government. 

4

Export and Investment Guarantees Act 1991. 

Page 50 GAO-04-531 Export-Import Bank 
Appendix II


Loss Estimation Practices of Foreign Export


Credit Agencies


confidence, that it will break even financially.

5

 Simultaneous attainment of 

these two objectives suggests this ECA has to strike a balance in the types 

of transactions and the nature of risks it shall undertake. The ECA’s risk 

premia and larger transactions are subject to approval by the U.K. treasury 

department. The level of treasury department control increased following 

certain losses the ECA incurred in the late 1990s. Plans are under way to 

convert the U.K. ECA into a separately capitalized, self-sustaining entity 

that would operate at arm’s length from the U.K. government, responsible 

for managing its own financial losses.6 

Different ECA missions and structures can have implications for ECA risk 

profiles and, thereby, reserve practices. For example, with its broader 

mandate, about 60 percent of the Canadian ECA’s 2003 portfolio exposure 

was to U.S. and Canadian borrowers. In contrast, most of the U.K. ECA’s 

ten most active markets in fiscal years 2001 and 2002 were emerging 

markets, representing about three-fourths of its activity in these years.

7 

These different risk profiles affect the level of loss reserves that these 

ECAs hold. According to the Canadian ECA’s financial statements, its 

allowances for loss averaged about 10 percent of its total exposure during 

calendar years 2000-2003. According to the U.K. ECA, its allowances for 

loss averaged about 20 percent of total exposure between fiscal years 2000­

2003.8

 It is important to note that, for business undertaken since 1991, the 

U.K. ECA is expected to maintain reserves equal to at least 150 percent of 

5

According to U.K. officials, a mandate to break even over the long term has been in effect 

since the ECA’s inception, but over time this has been translated into quantifiable objectives. 

This mandate currently applies to all business undertaken since 1991 that meets the ECA’s 

underwriting criteria. The mandate does not apply to business that the ECA is directed to 

undertake on the basis of national interests but that does not meet its underwriting criteria. 

6

According to U.K. ECA officials, the conversion of their entity to a self-sustaining “Trading 

Fund” is scheduled to take place by 2007. 

7

The U.K. ECA’s fiscal year begins on April 1 and ends on March 31. The above figure 

represents the ECA’s activity for the fiscal years ending March 31, 2002 and 2003. 

8

This figure reflect allowances on the U.K. ECA’s pre-1991 and post-1991 activities and 

includes allowances on paid claims and future amounts at risk. 

Page 51 GAO-04-531 Export-Import Bank 
Appendix II


Loss Estimation Practices of Foreign Export


Credit Agencies


expected losses.9 In comparison, the U.S. Export-Import Bank’s (Ex-Im 

Bank) loss allowances have averaged about 18 percent of its total exposure 

since fiscal year 1999. 

Moreover, different degrees of government support affect the extent to 

which ECAs are responsible for managing their own financial risk and 

protecting taxpayers from loss. For example, as a self-sustaining entity, the 

Canadian ECA does not receive annual budgetary support from its 

government and would be expected to cover any losses it incurs.

10 In 

contrast, although the U.K. ECA is expected to break even over time, it 

receives appropriations from the U.K. Parliament to cover anticipated 

losses and administrative expenses. It also operates with a treasury 

department guarantee of the obligations arising from its guarantees. 

Both the Canadian and the U.K. ECAs follow accrual-based accounting 

standards, in which revenue and expenses are recorded in the period they 

are earned or incurred, even though they may not have been received or 

paid.

11 Under such accounting, loss reserves are an estimate of probable 

losses in a portfolio as a whole. The reserves are normally recorded long 

before actual defaults occur. This contrasts with cash flow accounting, in 

which revenue is recognized when it is received and expenses when they 

are paid. As discussed in the section on the French and German ECAs, this 

method of accounting precludes the matching of revenue and expenses 

over time. 

9

The U.K. ECA must achieve a “Reserve Coverage Ratio” of at least 1.5 times the level of 

future expected losses in its portfolio. Because the U.K. ECA is expected to generally break 

even, including during periods when losses are concentrated and thus unusually high, it is 

expected to reserve at a level that is higher than would be needed to cover expected losses 

on average over a long period. The extra reserves are to cover what are sometimes called 

“unexpected losses.” With these higher reserve levels, reserves should be adequate to cover 

losses 75 percent of the time, according to U.K. ECA officials. 

10According to the Canadian ECA, its overall operations have resulted in a profit in every 

year but one. 

11The Canadian ECA is required to follow Canadian Generally Accepted Accounting 

Principles (GAAP), which are similar to U.S. private-sector GAAP and include the use of 

accrual-based accounting. The U.K. ECA follows U.K. government accounting standards, 

which are accrual-based standards. This ECA practiced cash flow accounting for many 

years but switched to accrual-based accounting several years ago. 

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Canadian and U.K. ECAs 

Have Recently Adopted, or 

Will Implement, New 

Reserve Methodologies 

Determining Risk Ratings and 

Calculating Probability of 

Default 

The Canadian and U.K. ECAs have recently revised their existing reserve 

practices by adopting or moving toward implementing methodologies that 

are designed to more precisely measure risk in their portfolios and ensure 

that their reserves reflect those risks. In 2001, the Canadian ECA and the 

Canadian Office of the Auditor General, who audits the ECA’s financial 

statements, undertook a review of the ECA’s reserve methodology with the 

goal of making it reflect current best practices. The ECA studied the 

reserve practices of several leading U.S. and Canadian banks and other 

ECAs, including Ex-Im Bank, and examined new developments in bank 

regulatory and accounting guidance.

12 According to Canadian ECA 

officials, it adopted a new risk assessment model that follows the risk 

assessment approaches used by some other financial institutions with 

international risk exposures. The new methodology did not have a 

substantial impact on the ECA’s level of reserves, although the entity 

changed the process by which it calculated its reserves, specifically its 

components and what it covers. For example, it began establishing 

reserves for committed undisbursed credits, which it had not done 

previously. 

In 1999 the U.K. treasury department hired a private consulting firm with 

credit risk expertise to review the effectiveness of the ECA’s risk 

management systems because of concerns about the ECA’s financial 

condition, given the larger than expected losses it incurred during the 

Asian financial crisis. According to U.K. ECA officials, the consulting firm 

concluded that the ECA’s process for estimating expected loss was 

reasonable but recommended, among other things, that the U.K. ECA 

should better assess the risk of, and establish capital to buffer against, 

unexpected losses.

13 The U.K. ECA is upgrading its existing risk assessment 

models and processes in response to the review. 

The Canadian and U.K. ECAs each use a combination of rating agency data 

and their own analyses and adjustments in determining ratings levels and 

default probabilities. For rating corporate risk, the Canadian ECA uses 

ratings from major rating agencies such as Moody’s Investors Service and 

12The Canadian ECA examined the Ex-Im Bank loss estimation methodology in place at the 

time of its benchmarking exercise that began in 1999, which differed from the loss 

estimation methodology implemented by the Office of Management and Budget for fiscal 

year 2003 that is described in this report. 

13Risk Management Review for HM Treasury and ECGD, KPMG, December 1999. 

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Standard & Poor’s when they are available; when these ratings are not 

available, the Canadian ECA’s risk department assigns ratings using 

standard rating agency criteria. They place credits into seven risk 

categories. The Canadian ECA then estimates its default probabilities for 

its corporate borrowers using published default rates from Moody’s 

Investors Service and Standard & Poor’s, taking into account the maturity 

of the credits. The Canadian ECA rates sovereign borrowers based on its 

own research and country knowledge. Once these ratings are assigned, the 

Canadian ECA uses the default probabilities associated with those ratings 

from Standard & Poor’s and Moody’s in determining default probabilities. 

For both corporate and sovereign borrowers, the Canadian ECA adjusts 

rating agency default probabilities where it believes such adjustments are 

necessary. 

For determining sovereign default probabilities and risk ratings, the U.K. 

ECA uses a model it developed in 1991 that assesses countries’ likelihood 

of default, using macroeconomic data such as borrower country 

indebtedness. Its analysts consider the model’s output and additional 

factors, including other country data, rating agency sovereign ratings and 

interest rate spreads, in the final assignment of sovereign ratings. For 

determining expected loss, the expected duration of default periods and 

the recovery rates when defaults occur are taken into account, along with 

the probability of default. 

For rating corporate transactions, the U.K. ECA uses rating agency 

corporate risk ratings where they are available. For corporations that are 

not rated by the major rating agencies, the U.K. ECA assigns ratings using 

templates developed with a major rating agency. In both cases, once these 

ratings are obtained, U.K. ECA officials adjust them, in some cases, based 

on a comparison with country sovereign ratings. For assigning expected 

losses to different risk ratings, U.K. ECA officials use a Standard & Poor’s 

tool that is based on that rating agency’s historical data on ratings 

transition and default rates and that incorporates other information such as 

recovery rates. 

U.K. ECA officials are moving toward a new modeling process that will 

directly assess, not only the risk of expected loss, but also the capital 

needed to cover unexpected losses or the risk of having greater losses 

concentrated in certain periods. This model was developed in consultation 

with a U.K. credit risk expert and uses a combination of private ratings 

agency data on sovereign bond defaults from the 1990s and U.K. ECA data 

on the 1980s default experience of the U.K. ECA. 

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Calculating Expected Loss	 Once default probabilities have been determined, determining the expected 

losses from the defaults involves determining the likely amount of loss 

when defaults occur, based on expected recoveries. The Canadian ECA 

uses its own historical data, where sufficient, to estimate recoveries for 

sovereign and nonsovereign borrowers. The U.K. ECA determines its own 

recovery rates for sovereign borrowers; for corporate borrowers, it makes 

some use of rating agency recovery data.

14 Both ECAs assume higher losses 

(lower repayments) for corporate than sovereign defaults.

15 The Canadian 

ECA also assumes that higher losses will be incurred from defaults on 

unsecured credits than on collateralized credits. The calculation of 

expected loss forms these entities’ base reserves amount, to which certain 

upward adjustments are made. These adjustments reflect the potential 

unexpected losses that are affected by the portfolio effects of 

concentration and correlation of financing activities. 

Adjusting for Portfolio Risk	 The Canadian ECA follows a portfolio approach in estimating loss and 

calculating reserves. In such an approach, the base reserve amount is 

adjusted upward because of additional risks related to concentrations of 

exposure and correlations among credits. The Canadian ECA adds reserve 

amounts for significant exposures to single borrowers, countries, or 

industries. It also adjusts upward for the possibility that problems in one 

area (for example, in one country) will spread to other parts of its portfolio. 

The U.K. ECA’s current approach includes some judgmentally determined 

upward adjustments to its base expected loss calculations for certain 

concentrations of risk. These include upward adjustments for public, 

nonsovereign borrowers, as well as certain systemic risks related to other 

countries or industries. Its new risk management approach will make such 

adjustments more systematically, as part of its loss model. 

Determining Fees	 Canadian and U.K. ECA officials both said that their loss estimation 

methodologies help them determine what fees to charge borrowers for 

their products. Both ECAs agree to follow a risk rating and pricing 

agreement developed by participating Organization for Economic 

Cooperation and Development (OECD) countries, in which participants 

14For aircraft financing, the U.K. ECA uses data on the recovery or second-hand value of 

aircraft. 

15For the Canadian ECA, secured commercial debt has a lower probability of loss given 

default than does sovereign debt. 

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jointly develop country risk ratings for the purposes of determining the 

minimum fees to be charged at each risk rating.16 (More information about 

this agreement is provided below.) However, according to Canadian and 

U.K. ECA officials, they may apply higher fees if they determine that the 

fees do not adequately reflect their own assessment of the potential loss on 

a transaction. Officials from both ECAs stated that setting fee levels in 

relation to expected loss is an important component of their financial 

stability over time. 

Canadian and U.K. Reserve 

Methodologies Were Subject 

to Internal and External 

Review 

According to officials from the Canadian and U.K. ECAs, their reserve 

methodologies (including key assumptions and computer models) have 

been or are being reviewed extensively, both internally and externally, 

before being adopted. The Canadian ECA’s new methodology was 

positively reviewed by an independent national accounting firm with 

significant experience in reviewing loan loss methodologies. The U.K. 

ECA’s current reserve practices were subject to review by a private 

consulting firm. In responding to the consulting firm’s recommendations, 

the ECA has worked with the U.K. treasury, a prominent academic and 

credit risk expert, and a private rating agency to develop its new approach. 

Its new risk assessment model is based on a well-known credit risk model 

that was developed by a leading U.S. bank.

17 

ECAs in France and 

Germany Use Fees to 

Offset Loss 

ECAs in France and Germany base their reserve practices primarily on the 

fees they collect for their products rather than on systematic estimations of 

their probable losses. These ECAs are private companies that offer export 

credit insurance on behalf of their respective governments, following 

certain risk thresholds that their governments establish for these accounts. 

Their governments expect these accounts to break even in the long run. 

The French and German ECAs are not expected to estimate future losses 

when transacting new business but rely instead on the OECD participating 

countries’ guidance in setting their fees. Neither France nor Germany 

annually appropriates budgetary funds to cover loss; instead, the fees the 

16This group, the Participants to the Arrangement on Officially Supported Export Credits, is 

not an official OECD body, but receives support from the OECD Secretariat. Its members 

include Australia, Canada, the European Community, Japan, Korea, New Zealand, Norway, 

Sweden, and the United States. 

17The underlying model, CreditMetrics, was introduced by JP Morgan in 1997. 

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ECAs collect constitute these countries’ reserve against future loss. The 

government ministries that oversee the ECAs conduct independent 

assessments of country risk in setting or adjusting the risk thresholds that 

specify the degree to which they will offer credit in certain countries. 

Further, the French ECA is developing a method, not yet in place, to more 

independently estimate future losses on the government’s export credit 

activities and to track the actual losses incurred over time. 

French and German ECAs 

Provide Export Insurance 

and Guarantees on Behalf of 

Their Governments and 

Follow Government 

Accounting Methods 

France and Germany provide and account for their official export credit 

business in similar ways. In both countries, the official ECA is a private 

enterprise that insures or guarantees exports on behalf, and at the 

direction, of the government. In addition to managing their government’s 

export credit business (referred to in both cases as the state account), the 

French and German ECAs also engage in business for their own account. 

The French and German state accounts extend primarily medium- and 

long-term export credit insurance, whereas the private enterprises that 

manage the state accounts primarily sell short-term insurance.

18 The ECAs 

are not responsible for any profit or loss incurred on the state account, 

which transfers to the government.

19 The French and German ECAs both 

receive administrative fees from the government for their services. 

The government ministries that oversee the ECAs make decisions about 

the degree to which the state accounts will offer export credits in certain 

countries or to certain borrowers (exposure limits are discussed further 

below). French and German state accounts are expected to operate in 

riskier markets where private export credit insurance cannot be obtained. 

In both countries, the government ministries can also direct the ECA to 

undertake certain transactions, even if doing so will cause it to exceed 

established exposure limits, if the government believes the transactions to 

be in the country’s best interest. 

The French and German state accounts are both directed to break even 

over the long term, meaning they should incur neither large gains nor 

losses. However, assessing compliance with this mandate is difficult, 

18The French and German state accounts do not directly finance exports. Private financial 

institutions handle this instead. 

19According to French and German ECA and government officials, the state accounts are 

operated separately from ECAs’ private account. Profit on the private account is not used to 

fund the state account. 

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because both governments’ budgets are accounted for on a cash flow basis. 

Under cash flow accounting, revenue is recognized when it is received, and 

expenses are recognized when they are paid. Thus, revenue in a given year 

is compared with expenses in that same year, regardless of when the 

underlying transactions occurred. Under this system, it can be difficult to 

know the degree to which the fees collected in a given year from providing 

export credit insurance cover any claims made against that insurance in 

later years. French and German ECA officials acknowledged that this 

accounting practice limits their ability to fully analyze actual or potential 

losses on the state account. The French ECA has been developing an 

alternative accounting approach that would enable such analysis, as 

discussed later. 

French and German ECAs 

Follow GovernmentDetermined Risk 

Thresholds and Use Fees to 

Cover Loss 

The French and German approaches to evaluating risk are based primarily 

on assessing country risk for the purpose of setting exposure limits and 

using fees to cover losses. The French and German ECAs are not expected 

to estimate expected losses in advance of undertaking transactions, but the 

French ECA provides informal risk assessments to the oversight ministry 

for it to consider when making decisions about undertaking transactions. 

The French and German governments do not provide budgetary funds at 

the beginning of a year to cover any losses that might be incurred during 

the year, but any losses incurred on the state account are automatically 

covered. 

The government ministries that oversee the French and German ECAs 

analyze borrower countries’ risk profiles when making their annual 

decisions about the exposure limits that will be in effect for a given year. 

This analysis may consider macroeconomic factors, OECD country risk 

ratings, and the ECA’s experiences with other countries’ repayment 

histories on previously extended credit. In France, the ECA also provides 

input to this analysis. These exposure limits, or ceilings, are developed to 

ensure portfolio diversification and constrain the accumulation of 

excessive risk levels. In both countries, the government determines risk 

ceilings and provides these to their ECAs to follow in operating the state 

account. Country risk ceilings can be exceeded only at the government’s 

direction. The German ECA also faces a statutory limit on the total 

exposure it can undertake in a given year.

20 

20A German ECA official told us that the statutory limit has never precluded it from 

undertaking any business that it wanted to undertake for the state account. 

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In both countries, the fees collected on the export credit business are 

viewed as a reasonable approximation of the amount of loss likely to be 

incurred. In setting fees, both ECAs follow the guidance agreed to by the 

participating OECD countries for assigning risk ratings to sovereign 

borrowers and charging premium rates. These ECAs add surcharges to the 

OECD minimum fee rates for corporate borrowers, recognizing the higher 

risk of corporate business. As discussed below, the OECD fees were 

politically determined, and both entities have considered whether the 

premia are sufficient to cover actual losses. 

France and Germany differ in how they manage their fee revenue. In both 

countries, the revenue belongs to the government. However, in France, 

some fee revenue is kept with the French ECA for the purpose of paying 

expenses that are incurred on the state account, such as paying a claim on 

a defaulted credit. Officials of the French ministry that oversees the ECA 

told us that the amount left on deposit with the ECA is based on their best 

estimate of the losses that the ministry expects will materialize in a given 

year. A German ECA official said that all fee revenue it collects is 

immediately transferred to the German government. When the German 

ECA has to pay a claim, it must request funds from the German 

government. 

French ECA and government officials told us that the French ECA is 

developing a new accounting system for the state account that will enable 

it to analyze, for each underwriting year, the collected fees and the claims 

corresponding to the transactions covered during the same year. This 

system will provide the ECA with historical data on payment experience in 

order to calculate expected losses on a statistical basis. However, the 

process is not complete, and the information it has produced is not used for 

official purposes. The approach in development still uses OECD minimum 

fees as the baseline for estimating loss but will add surcharges to take 

account of increased risk, for example, when a default is pending. 

Surcharges will also be added for risks other than sovereign risks. 

According to French ECA and government officials, a key challenge in 

developing this approach was compiling payment histories for individual 

transactions. They also stated that before the French state account would 

develop a reserve system that does not rely on the OECD minimum fees, 

further accumulation of historical data on payment experiences will be 

necessary, a process they expect will take some time. 

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OECD Participating 

Countries’ Risk 

Assessment and Fee 

Arrangement 

The agreement of the participating OECD countries regarding country risk 

classifies countries into seven risk categories on the basis of a country risk 

assessment model. The model ranks countries according to which is most 

likely to default, considering indicators of countries’ financial and 

economic situations. It also uses data provided since 1999 by export credit 

agencies on their payment experiences with countries. Quantitative scores 

for each country determine its initial risk classification, which can be 

adjusted by participating countries based on an assessment of political risk 

and other factors not considered in the model itself. 

While the model scores provide some indicator of default probabilities for 

each country, they are not used in determining what the risk premiums, or 

fees, should be to cover expected loss for financing to sovereign buyers in a 

risk category. The fees result from a political agreement, an averaging of 

fees in place in 1996 across member export credit agencies. Thus, the fees 

reflect the expected loss of lending to sovereign borrowers at various risk 

levels only to the extent that the average of 1996 fees across participating 

countries reflect those expected losses. The minimum common fees are 

not intended to reflect the generally higher risk of lending to nonsovereign, 

or private, borrowers within the same country, according to OECD and 

ECA officials. 

Participating OECD countries are collecting data from their ECAs on their 

financing and repayment experiences since 1999, in order to assess the 

validity of the current fees as indicators of expected loss. According to an 

ECA official who chairs a group of country risk expert from OECD 

countries, collecting enough data to assess the current premiums will take 

at least 10 years. 

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Appendix III 

Loan Loss Allowance Guidance and Select 

Commercial Bank Practices 

Loans are the largest component of most depository institutions’ assets; 

therefore, the loan loss allowance1

 is critical to understanding the financial 

condition of a depository institution and changes in credit risks and 

exposures. Given the importance of the loan loss allowance as an indicator 

of financial condition, and because adjustments to the allowance affect an 

institution’s earnings, the loan loss allowance is scrutinized by regulatory 

agencies. Regulators and the accounting profession acknowledge that 

calculating the loan loss allowance requires significant judgment and that 

accounting and regulatory guidance are not prescriptive. For the past 

several years, the organizations involved in developing U.S. private sector 

accounting standards—the Financial Accounting Standards Board (FASB) 

and the American Institute of Certified Public Accountants —have been in 

the process of reviewing current loan loss allowance guidance. Likewise, 

the U.S. federal banking regulators—the Federal Reserve Board (FRB), 

Office of the Comptroller of the Currency (OCC), Federal Deposit 

Insurance Corporation (FDIC), Office of Thrift Supervision, and the 

National Credit Union Administration—and the Securities and Exchange 

Commission have been updating regulatory guidance governing the loan 

loss allowance. While the commercial banks we contacted follow the basic 

concepts of accounting and regulatory guidance, specific aspects of these 

banks’ allowance methodologies differ. Regulatory guidance requires U.S. 

banks involved in international lending to address additional risks, in 

addition to the accounting and loan loss allowance concepts that apply to 

domestic lending. 

Loan Loss Allowance Is 

an Important Factor in 

an Institution’s 

Financial Condition 

The loan loss allowance plays a key role in the financial condition of a 

bank.

2

 It reflects a bank’s judgment of the overall collectibility of its loan 

portfolio; that is, the higher the percentage of a bank’s loan loss allowance 

to its total loan portfolio, the lower the estimated collectibility of the loan 

portfolio and the higher the estimated level of credit risk.

3

 It also reflects 

1

Different phrases are used interchangeably when discussing credit loss reserves, including 

loan loss reserves, allowance for loan and lease losses, and allowance for credit losses. We 

will use the phrase “loan loss allowance.” 

2

Loan loss allowance guidance applies to banks and other financial institutions. We discuss 

banks in this appendix because our review focuses on lending done by commercial banks 

for purposes of comparison with the Export-Import Bank. 

3

Credit risk is the potential for financial loss resulting from the failure of the borrower or 

counterparty to perform on an obligation. 

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the amount of estimated losses that have occurred in the loan portfolio but 

have not yet been realized. The loan loss allowance, according to bank 

regulatory guidance, must be appropriate to absorb estimated credit losses 

inherent in the loan portfolio. When changes are made in the loan loss 

allowance, these changes directly affect an institution’s earnings. The loan 

loss allowance is established and maintained by charges against the bank’s 

operating income, which reduces earnings,4

 or by reversals of the 

allowance that would increase earnings. 

Given the loan loss allowance’s effect on earnings and the role the 

allowance plays in allowing banks to cover probable and estimable losses, 

U.S. financial regulatory agencies pay close attention to a bank’s loan loss 

allowance. These regulators require banks to establish and regularly review 

the adequacy of their allowance, and bank examiners assess the asset 

quality of an institution’s loan portfolio and the adequacy of the loan loss 

allowance. Because regulatory guidance is not prescriptive, bank 

regulators told us that, through examinations, they assess the 

“reasonableness” of a bank’s loan loss allowance by comparing a bank’s 

loan loss allowance level with industry standards and looking for 

justification for any methodology that could be considered an outlier. As 

part of their assessment of public company filings, the Securities and 

Exchange Commission also reviews banks’ loan loss allowance 

disclosures. 

Accounting and 

Regulatory Guidance 

Are Not Prescriptive; 

the Loan Loss 

Allowance Requires 

Significant Judgment 

Regulatory agencies told us that their guidance is not prescriptive, and 

accounting and regulatory guidance states that the loan loss allowance 

requires a significant amount of judgment. Because no single approach has 

been determined to encompass the wide variety of banks’ loan portfolios 

and their varying degree of risk and unique historical loss experience, 

regulatory and accounting guidance provide principles and guidelines for 

banks to follow, rather than specific formulas and factors for banks to use 

in their allowance calculations. The bank regulators direct institutions to 

follow U.S. generally accepted accounting principles (GAAP), as it applies 

to the loan loss allowance, for regulatory reporting purposes. Specifically, 

4

The management of a bank adjusts the level of its loan loss allowance through periodic 

provisioning to offset charge-offs to reflect the level of estimated losses in the loan 

portfolio. Provisions are an expense charged against an institution’s current earnings and 

represent the amount necessary to adjust the loan loss allowance to reflect probable and 

estimable uncollectible loan balances. 

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banks follow Statement of Financial Accounting Standards (SFAS) 114, 

Accounting by Creditors for Impairment of a Loan, in estimating losses 

from individual impaired5

 loans. Further, SFAS 5, Accounting for 

Contingencies,

6 provides guidance to banks in their calculation of losses 

for pools of loans, impaired or performing, which are evaluated 

collectively. 

The bank regulators we spoke with—FRB, OCC, and FDIC—stated that 

regulatory guidance is coordinated across all the banking regulatory 

agencies and is consistent with GAAP. On March 1, 2004 the banking 

regulators issued an Update on Accounting for Loan and Lease Losses, 

which addresses recent developments in accounting for the loan loss 

allowance and presents a list of the current sources of GAAP and 

supervisory guidance for accounting for the loan loss allowance. One of the 

sources it lists is The Interagency Policy Statement on the Allowance for 

Loan and Lease Loss, which was issued by FRB, OCC, FDIC, and the Office 

of Thrift Supervision in 1993. This document discusses the nature and 

purpose of the loan loss allowance, the responsibilities of a bank’s board of 

directors and management, how banks should determine the adequacy of 

their allowance and the factors that should be considered in their 

estimates, and examiners’ responsibilities with regard to the loan loss 

allowance. Prior to the March 2004 Update on Accounting for Loan and 

Lease Losses, the 1993 interagency policy was supplemented by the 2001 

Federal Financial Institutions Examination Council7

 Policy Statement, 

discussed later. 

In addition to the interagency policy, OCC and FDIC issue their own loan 

loss allowance policy statements that they distribute to banks under their 

supervision. These statements are in line with the interagency policy. 

5

A loan is impaired when, based on current information and events, it is probable that a 

creditor will be unable to collect all amounts due according to the contractual terms of the 

loan agreement. 

6

SFAS 5 defines a contingency as an existing condition, situation, or set of circumstances 

involving uncertainty as to possible gain or loss to an enterprise that will ultimately be 

resolved when one or more future events occur or fail to occur. 

7

The Federal Financial Institutions Examination Council is an interagency body empowered 

to prescribe uniform principles, standards, and report forms for the federal examination of 

financial institutions by the federal banking regulators and to make recommendations to 

promote uniformity in the supervision of financial institutions. 

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Table 1 provides a summary of the relevant accounting and regulatory 

guidance governing the loan loss allowance. 

Table 1: Summary of Accounting and Regulatory Guidance Followed by Banks in Their Loan Loss Allowance Calculation 

Accounting guidance Regulatory guidance 

Individual impaired loans 

Conditions: Under SFAS 114, a loan is impaired when it is Conditions: Banks determine impairment using their loan review 

probable that the bank will be unable to collect amounts due procedures. Generally, a loan is impaired for the purposes of 

according to the terms of the loan. Banks determine impairment SFAS 114 if it exhibits the same level of weaknesses and 

using normal loan review procedures. probability of loss as loans (or portions of loans) classified as 

“doubtful” or “loss.” (See table 2 for risk classifications.) 

Measurement of impairment: Under SFAS 114, one of the Measurement of impairment: SFAS 114 guidance should be 

following methods must be used: followed. Regulators expect that loan loss allowances for all 

• present value of expected future cash flows discounted at the impaired, collateral dependent loans will be based on the fair 

loan’s effective interest rate, value of the collateral for purposes of regulatory reports. 

• loan’s observable market price, and 

• fair value of collateral if the loan is collateral dependent. 

Pools of loans 

Conditions: Under SFAS 5, the following conditions must be met: Conditions: Banks should follow guidance in SFAS 5 for


(1) it is probable that a loan has been impaired at the financial measuring losses for pools of loans.


statement date and (2) the amount of loss can be reasonably


estimated. Under SFAS 114, some impaired loans may have risk


characteristics in common with other impaired loans, as such a


bank may aggregate those loans for evaluation of impairment.


Measurement of impairment: According to SFAS 5, whether the 

amount of loss can be reasonably estimated will depend on, 

among other things, the experience of the bank, information about 

the ability of individual debtors to pay, and analysis of the loans in 

light of the current economic environment. In the case of a bank 

with no relevant experience, reference to the experience of other 

enterprises in the same business may be appropriate. According 

to the interpretation of SFAS 5 (FASB interpretation 14), when a 

reasonable estimate of a loss is a range and when some amount 

within the range appears at the time to be a better estimate than 

any other amount within the range, that amount will be accrued. 

When no amount within the range is a better estimate than any 

other amount, the minimum amount in the range will be accrued. 

Measurement of impairment: Because no single approach has 

been determined to be appropriate for all banks, a specific 

method to determine historical loss experience is not required. 

• The method a bank uses will depend to a large degree on the 

capabilities of its information systems. 

• Acceptable methods range from a simple average of the bank’s 

historical loss experience over a period of years to more 

complex “migration” analysis. 

• There is no fixed historical period that should be analyzed by 

banks to determine average historical loss experience. 

Source: GAO analysis of accounting and regulatory guidance. 

Additional Guidance on According to bank regulators, the accounting and regulatory guidance 

International Lending	 discussed above and described in table 1 applies to both domestic and 

international lending. However, bank regulators stated that because 

international lending involves more risk than domestic lending, banks that 

lend internationally must follow additional guidance. The primary 

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Commercial Bank Practices 

additional risk that banks face when providing international loans is 

“country risk,” or the risk that economic, social, and political conditions 

and events might adversely affect a bank’s interests in a country. A specific 

component of country risk is “transfer risk,” or the possibility that a loan 

may not be repaid in the currency of payment because of restricted 

availability of foreign exchange in the debtor’s country. 

To address country risk, banks are expected to have country risk 

management methodologies in place. A 1998 study by the Interagency 

Country Exposure Review Committee (the “Committee”) found that all U.S. 

banks conducting international lending had developed formal country risk 

management programs and policies.8

 The Committee also found that these 

banks had formal internal country risk monitoring and reporting 

mechanisms and that country risk management was typically integrated 

with credit risk management. To address transfer risk, banks that lend to 

specific countries must allocate additional allowances, called the Allocated 

Transfer Risk Reserve.9 

Transfer risk is one component of the broader concept of country risk and 

the only component specifically regulated by the bank regulators. The 

International Lending Supervision Act of 1983 required banks to set up an 

allocated allowance for assets subject to transfer risk, and the banking 

regulators accordingly published regulations implementing the 

requirement. The Committee is responsible for providing an assessment of 

the degree of transfer risk in cross-border and cross-currency exposure of 

U.S. banks and sets the minimum amount of the allocated transfer risk 

reserve.

10 The Committee bases its assessments and ratings on information 

collected from a number of sources, including country analysis prepared by 

economists at the Federal Reserve Bank of New York and discussions with 

U.S. banks.11 

8

The Committee is composed of representatives of the OCC, FDIC, and FRB. 

9

The allocated transfer risk reserve is a specific allowance that is created by a charge to 

current income. The allocated transfer risk reserve is separate from the loan loss allowance 

and is deducted from gross loans and leases. As far as financial statement reporting, FRB 

officials told us that the allocated transfer risk reserve normally appears as part of the loan 

loss allowance, that is, it is not identified separate of the allowance. 

10The Committee meets three times a year to review countries to which U.S. banks have had 

an aggregate exposure of $1 billion or more for at least two consecutive quarters. 

11Two of the three banks that we spoke with stated that they were included in the 

Committee’s process. 

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Bank regulators emphasized that the Committee’s transfer risk ratings are 

primarily a supervisory tool and should not replace a bank’s own country 

risk analysis process. FRB officials also told us that the allocated transfer 

risk reserve is “narrowly prescribed” in that it applies only to a small 

number of countries. U.S. commercial bank lending is primarily domestic, 

and the international lending that is conducted by banks is concentrated in 

the G-10 countries12 and Switzerland. The FRB officials stated that only 

approximately 30 U.S. banks—a small portion of the total number of banks 

in the United States—receive allocated transfer risk reserve statements. 

Regulatory Guidance on 

Portfolio Segmentation and 

Risk Ratings 

In addition to loan loss allowance guidance, banks must also follow 

regulatory guidance regarding loan portfolio segmentation and risk 

classification. Segmenting the bank’s loan portfolio into groups of loans 

with similar characteristics, such as risk classification, past-due status, 

type of loan and industry, or the existence of collateral, is the first step in 

calculating the loan loss allowance for the SFAS 5 portion. Regulatory 

guidance states that banks may segment their loan portfolios into as many 

components as practical. Bank regulators do not prescribe the way that 

banks should segment their loans; however, regulatory guidance states that 

loan segmentations should be separately analyzed and provided for in the 

loan loss allowance. Bank regulators do provide guidance on risk 

classification, a characteristic by which loan portfolios can be segmented. 

Table 2 provides definitions of the risk classifications, which are shared by 

all of the banking regulatory agencies. 

12The G-10 countries (in addition to the United States) are Belgium, Canada, France, 

Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden, and the United Kingdom. 

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Table 2: Regulatory Agencies’ Risk Rating Scale 

Risk category Definition 

Pass A pass asset presents no inherent loss (no formal

regulatory definition exists for “pass” credits).

Special mention A special mention asset has potential weaknesses that

deserve management’s close attention. If left uncorrected, 

these potential weaknesses may result in deterioration of

repayment prospects for the asset or in the institution’s 

credit position at some future date. Special mention assets

are not adversely classified and do not expose an 

institution to sufficient risk to warrant adverse

classification.

Substandard A substandard asset is inadequately protected by the 

current sound worth and paying capacity of the obligor or 

of the collateral pledged, if any. Assets so classified must

have a well-defined weakness, or weaknesses, that

jeopardize the liquidation of the debt. They are 

characterized by the distinct possibility that the bank will

sustain some loss if the deficiencies are not corrected.

Doubtful An asset classified doubtful has all the weaknesses

inherent in one classified substandard with the added

characteristic that the weaknesses make collection or

liquidation in full, on the basis of currently existing facts,

conditions, and values, highly questionable and 

improbable. 

Loss Assets classified loss are considered uncollectible and of

such little value that their continuance as bankable assets

is not warranted. This classification does not mean that the 

asset has absolutely no recovery or salvage value, but 

rather that it is not practical or desirable to defer writing off 

this basically worthless asset even though partial recovery

may be effected in the future.

Source: OCC guidance.

Bank regulatory guidance states that a bank’s rating system should reflect 

the complexity of its lending activities and the overall level of risk involved; 

the guidance also states that no single credit risk rating system is ideal for 

every bank. Large banks typically require sophisticated rating systems with 

multiple rating grades within the above broad risk classifications. One bank 

regulator stated that some banks might have a 10-point rating system based 

on the risk classifications, whereas other banks may have up to 25 different 

ratings. 

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Regulatory Agencies For the past several years, financial regulatory agencies and accounting 

organizations have updated and continued reviewing U.S. private sector 

and Accounting accounting standards and regulatory guidance governing the loan loss 

Organizations Have allowance. 

Been Reviewing Loan 

Loss Allowance 

Guidance 

Regulatory Agencies 

Supplement Existing 

Guidance 

In the late-1990s, Securities and Exchange Commission staff noted in their 

normal reviews of filings by financial institutions, including banks, that 

there were inconsistencies between the disclosures about the credit quality 

of registrant’s loan portfolios and the changes in the loan loss allowances 

reported in the financial statements. The Securities and Exchange 

Commission staff’s review was aimed at determining whether the 

institutions were complying with GAAP for loan loss allowances. Securities 

and Exchange Commission staff was concerned, as were some of the bank 

regulators, that financial institutions were (1) not using procedural 

discipline in developing loan loss allowance estimates; (2) not 

documenting their evaluation of loan credit quality or their measurement of 

loan impairment; or (3) not providing clear disclosure, in the financial 

statements and management’s discussion and analysis, about the 

provisioning process and allowance analysis. 

As a result of the Securities and Exchange Commission staff’s review of 

filings, one bank restated its financial results to reflect a reduction in its 

loan loss allowance. According to a bank regulator, although the credit 

quality of the bank’s loan portfolio was increasing, its loan loss allowance 

was not decreasing. 

Financial regulatory agencies issued additional guidance on the loan loss 

allowance. In March 1999, the FDIC, FRB, OCC, Office of Thrift 

Supervision, and Securities and Exchange Commission issued a joint letter 

to financial institutions on the loan loss allowance, in which they agreed to 

establish a joint working group to study the loan loss allowance and 

provide improved guidance focusing on appropriate methodologies and 

supporting documentation and enhanced disclosures. In 2001, the Federal 

Financial Institutions Examination Council finalized and issued its Policy 

Statement on Allowance for Loan and Lease Losses Methodology and 

Documentation, which supplements existing regulatory guidance. The 

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Policy Statement was intended to provide further guidance on the design 

and implementation of loan loss allowance methodologies and supporting 

documentation practices. Securities and Exchange Commission staff 

issued parallel guidance on this topic for public companies in Staff 

Accounting Bulletin No. 102. 

Accounting Guidance for 

the Loan Loss Allowance is 

Under Review 

FASB is charged with establishing authoritative private sector accounting 

principles for financial reporting.13 These accounting principles (GAAP) are 

promulgated primarily through the SFAS issued by FASB. In the past, the 

American Institute of Certified Public Accountants (the “Institute”) has 

issued industry and auditing guides to provide accounting implementation 

guidance, subject to clearance by FASB.14 

The Institute organized a loan loss task force with observers from the OCC, 

Securities and Exchange Commission and FASB on accounting for loan 

losses to “narrow the boundaries” of what is acceptable under GAAP. The 

Institute’s exposure draft of a proposed Statement of Position, “Allowance 

for Credit Losses,” was released for public comment in June 2003 and 

discussed the following: the distinction between current and future losses; 

how to reconcile acceptable methods for measuring loss incurred for 

specific loans versus pools of loans that are collectively evaluated; 

disclosure requirements; and the appropriate use of observable data in the 

loan loss allowance calculation. As discussed in the March 2004 Update on 

Accounting for Loan and Lease Losses, the proposed Statement of 

Position raised concerns among the banking regulators and other members 

13Since 1973, FASB has been the designated private sector organization responsible for 

establishing standards of financial accounting and reporting, which govern the preparation 

of private sector financial statements. FASB accounting standards are recognized as 

authoritative by the Securities and Exchange Commission and the Institute. 

14The Securities and Exchange Commission has statutory authority to establish accounting 

principles but, as a matter of policy, it generally has relied on FASB to provide leadership in 

establishing and improving accounting principles and standards. The Securities and 

Exchange Commission issued a Policy Statement on April 25, 2003 recognizing FASB as a 

designated accounting standard setter. 

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of the financial community who commented on the draft. In January 2004, 

after review of these comment letters, the Institute decided to proceed only 

with guidance to improve disclosures.15 

Reviewed Banks 

Follow Basic Concepts 

in Accounting and 

Regulatory Guidance 

but Vary in Allowance 

Methodologies 

We spoke with three U.S. commercial banks with large lending portfolios 

totaling approximately $800 billion, including large international 

exposures.16 The three banks we spoke with follow the basic accounting 

and regulatory concepts outlined earlier but vary in specific loan loss 

allowance methodologies, including the sources of and amount of 

observable data on which their allowance calculations are based. FRB, 

which is conducting a study to establish “core reserving practices” among 

banks, confirmed that loan loss allowance practices among banks are not 

universal. The loan loss allowance varies depending on the type of lending 

done by the bank and its associated levels of risk. In addition, each bank 

has a unique historical loan loss experience on which their reserve 

calculation is based. 

Despite specific differences in loan loss allowance methodologies, banks 

follow the same basic steps in determining their loan loss allowance levels 

for both domestic and international loan portfolios. These steps are 

illustrated in figure 7. 

15The Institute’s loan loss task force will evaluate existing loan loss allowance disclosure 

requirements and disclosure recommendations received through the comment process and 

will develop a document on list of recommended disclosure enhancements. 

16See appendix I for a further discussion of our methodology. 

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Figure 7: Example of a Commercial Bank’s Loan Loss Allowance Process for Corporate Loans 

Step A 

Corporate loans are assigned a commercial 

risk rating. For international loans, this rating 

is then compared to the sovereign risk rating. 

The loan receives the higher (worse) rating of 

the two. In our example, we used a 10-point 

rating system. 

1 2 7 9 10 

"Pass" category Impaired loans 

Loan rating 

Step B 

Calculated according to accounting guidance 

SFAS 5, the general allowance is the sum of 

the allowances for each loan pool (in our 

example, loans are pooled only by risk rating). 

For specific allowances SFAS 5 or SFAS 114 

accounting guidance is used depending on 

the dollar amount, which also determines 

whether the allowances are calculated on 

an individual or pooled basis. 

In practice, in calculating the loan loss 

allowance banks consider various factors 

including imprecision in the financial models 

used and changing economic conditions 

that may impact forecasted loan losses. 

General allowance Specific allowance 

For each risk rating, the following are calculated: 

(1) Probability of Default (PD): uses primarily 

external data from rating agencies 

(2) Loss Given Default (LGD): uses internal 

loss history, which can be supplemented by 

and compared to rating agency data. This 

factor can be lowered for collateral, 

guarantees, and other third-party support. 

(3) Expected Loss (EL): PD x LGD 

(4) EL x outstanding balance = general allowance 

Allowances for 

classified loans 

less than the 

specified dollar 

amount are 

pooled and 

calculated 

according to 

accounting 

guidance in 

SFAS 5, using 

a formula 

based on 

historical 

information. 

Allowances for 

classified loans 

greater than a 

specific dollar 

amount (which 

varies among 

banks) are 

calculated on 

an individual 

basis according 

to accounting 

guidance in 

SFAS 114. 

Step C 

General allowance and specific allowance 

are added together to arrive at the total 

loan loss reserve. 

Loan loss allowance 

3 4 5 6 8 

Source: GAO analysis of bank information and accounting and regulatory guidance. 

Assignment of Risk Ratings	 All three banks stated that their loan portfolios are divided between their 

commercial and consumer businesses. We focused on the commercial side 

of the loan loss allowance process of these banks, as it was most relevant 

to the business of the Export-Import Bank. Within their commercial loan 

portfolios (including both domestic and international lending), regulatory 

guidance allows banks to segment their loans according to various factors 

but risk classification is a primary factor. The banks assign loans different 

risk classifications, as defined by the bank regulators (see table 2), based 

on the creditworthiness of the loan. 

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The calculation of the loan loss reserve is dependent on the risk ratings 

assigned to loans. The assignment of risk ratings is based on an assessment 

that includes evaluating an obligor’s credit risk based on the company or 

project and also on external factors, such as country risk for international 

lending. 

The three banks’ approaches to the risk rating assignment and review 

process are multilayered and performed by multiple units within the banks. 

The banks we spoke with have risk management groups that are divided 

into specific risk units. The groups charged with evaluating credit risk are 

involved in assigning risk ratings. Ongoing analysis of the loan portfolio is 

performed to ensure that risk ratings continue to be accurate. Units within 

the risk management groups conduct reviews of selected loans in their 

portfolios throughout the year, sometimes focusing on credits in certain 

risk ratings ranges. 

Factors that banks and bank examiners take into consideration when 

analyzing risk in a credit exposure include industry risk; financial 

indicators such as quality of cash flow, balance sheet, debt capacity, and 

financial flexibility; and management. Officials at one bank told us that they 

use agency ratings as benchmarks to test the reasonableness of their 

internal credit risk grading system; however, the agency ratings are 

considered but not specifically weighted into their rating decision. 

All three banks we spoke with have committees that evaluate the country 

risk levels of their lending portfolios and establish country risk ratings and 

sometimes geographic exposure limits. Officials at one bank stated that 

they have a formal model that assigns risk ratings to countries. The model 

is based on economic, financial, social, and other factors. The three banks 

incorporate information from external sources—for example, private 

companies and ratings agency data—into these ratings. However, two 

banks told us that, although they use external sources for data and 

qualitative information, all of their analysis is internal. 

Officials at one bank told us that their committee holds bimonthly meetings 

and adjusts ratings monthly. Countries are placed on watch lists when 

economic conditions are unstable. The watch list is based on triggers, 

which include economic factors such as the pricing of debt, exchange 

rates, and other political and social factors. 

For international lending, the three banks factor their country risk rating, 

determined internally, into the rating that they assign a loan. A loan to a 

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foreign obligor is first rated based on the obligor’s creditworthiness, 

according to the banks we interviewed, then the country risk rating is 

incorporated to produce an overall rating for that loan. Both the banks and 

the bank regulators stated that, for international loans, the rating assigned 

to a loan generally will be no better than the country risk rating for the 

country in which the debtor is located. However, if a loan is collateralized 

or guaranteed by a third party, the loan may receive a rating better than the 

country risk rating. 

FRB officials stated that Interagency Country Exposure Review 

Committee’s (the “Committee”) country risk ratings and the allocated 

transfer risk reserve requirements often lag behind the ratings of the 

ratings agencies and changes already made by the banks in their reserve 

levels. The three banks stated that they make their own internal judgments 

regarding the allocated transfer risk reserve and can decide to have a 

higher allowance than the allocated transfer risk reserve requirement, 

although they cannot have a lower allowance. The banks, as did FRB 

officials, also stated that the allocated transfer risk reserve is a lagging 

indicator and that many specific losses have already been incurred by the 

time the allocated transfer risk reserve is issued by the Committee. 

Calculation of Loan Loss 

Allowance 

Based on direction from regulatory and accounting guidance, the three 

banks calculate loan loss allowances by grouping loans with similar 

characteristics into pools and calculating an allowance for each pool 

(which will be referred to as the “general allowance”). In other cases, banks 

calculate the loan loss allowance for certain loans on an individual basis 

(which will be referred to as the “specific allowance”). (Examples of 

general and specific allowance calculations are illustrated in figure 7, Step 

B.) In calculating the loan loss allowance, banks also consider and adjust 

for various factors including imprecision in the financial models used and 

changing economic conditions that may affect forecasted loan losses. 17 As 

with all aspects of a bank’s loan loss allowance methodology, regulatory 

17The recent exposure draft Statement of Position by the American Institute of Certified 

Public Accountants emphasizes that the loan loss allowance consists of only these two 

components. While the term “unallocated reserves” is commonly used in the banking 

industry, its specific meaning may vary. For some, it refers to adjustments to historical 

experience factors, while others believe that those adjustments are an element of the 

allocated allowance for loan losses. Others believe that unallocated refers to allowances for 

credit losses that are not attributable to individual loans, referred to as the “general 

allowance” in this appendix. 

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Calculation of the General 

Allowance 

Calculation of the Specific 

Allowance 

and accounting guidance require that support for these adjustments be well 

documented. 

In calculating the general allowance, loans are grouped into pools based on 

similar characteristics—risk classification being a primary factor—and 

collectively evaluated for impairment. The three banks we spoke with 

generate expected loss factors for each loan pool by estimating such 

factors as the probability of default, loss given default, and expected 

exposure at default. The three banks use internal and external data to 

estimate the probability of default and loss given default components. FRB 

officials told us that banks tend to use external data to calculate the 

probability of default and internal data to calculate the loss given default. 

The practices of the three banks in our study for the most part conformed 

to this view. The three banks primarily used internal data to calculate the 

loss given default, sometimes validated by looking at external data or 

supplemented with external data, and they primarily used external data 

sources to calculate the probability of default. 

With respect to the probability of default component, the banks weighted 

external sources differently and used different time periods of analysis. 

Officials at the three banks told us that they relied on external sources; 

however, officials at one bank told us that they also internally adjusted the 

data in their calculation. 

The length of the historical loss experience under analysis for the banks we 

interviewed varied among the loss given default components of the loan 

loss allowance calculation. The three banks we spoke with used an average 

of 16 years worth of data for the loss given default component. 

In their specific allowance calculation, the three banks told us that they 

calculate loan loss allowance for impaired loans that are larger than a 

specific dollar amount on an individual basis. Among the banks with whom 

we spoke, this amount ranged from hundreds of thousands of dollars to 

millions of dollars. This calculation follows the guidance in SFAS 114. For 

individual impaired loans, banks typically use the present value of 

discounted cash flows. One bank told us that expected loss factors based 

on an assessment of the loans’ loss potential are determined by 

consultation between loan officers and members of the risk management 

group. The discounted expected future cash flows are generated using 

expected loss factors, the remaining number of months that the loan is 

estimated to be nonperforming, the monthly interest rate when the 

obligation became nonperforming, and the gross principal balance when 

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Commercial Bank Practices 

the loan became nonperforming. The three banks periodically update their 

analysis of expected loss factors. A bank regulator told us that in the SFAS 

114 calculation, banks may develop best-, base-, and worst-case scenarios 

in order to make their best estimate. 

The three banks pool loans that are for less than the aforementioned dollar 

amount threshold and estimate losses for the loan pools. The calculation 

follows guidance in SFAS 5. Two of the banks we spoke with estimate the 

loss factors used in this calculation based on internal statistical studies of 

historical loss experience. 

Review of the Loan Loss 

Allowance 

The three banks we spoke with review their loan loss allowance at least 

quarterly, as part of the quarterly financial disclosure statements required 

by the Securities and Exchange Commission. However, the banks told us 

that they review large impaired loans monthly but make allowance 

decisions quarterly. The risk management groups within the three banks 

have the responsibility for estimating and formulating the allowance 

parameters and establishing the loan loss allowance. The 

recommendations and the basis of their formulation are reviewed by senior 

management, whose conclusions as to the appropriateness of the loan loss 

allowance, as well as the supporting analysis, are then reviewed quarterly 

by the bank’s board of directors. 

Page 75 GAO-04-531 Export-Import Bank 
Appendix IV 

Interagency Country Risk Assessment System 


Following enactment of the Federal Credit Reform Act in 1990, the 

Interagency Country Risk Assessment System (ICRAS)—a working group 

of executive branch agencies engaged in international credit activities— 

was formed to provide uniformity to the process for evaluating country risk 

and estimating the program costs. The Export-Import Bank (Ex-Im Bank) 

uses ICRAS ratings in determining the program costs of its sovereign 

financing and as a factor in its own rating process for its nonsovereign, or 

private, financing. The determination of expected loss rates under the 

ICRAS system has two components: (1) the assignment of risk ratings for 

particular borrowers or transactions and (2) the determination of loss rates 

for each risk category. Both Ex-Im Bank and the Office of Management and 

Budget (OMB) play key roles in the ICRAS process—OMB chairs ICRAS, 

and Ex-Im Bank provides country risk assessments and risk rating 

recommendations, which are then distributed to, and agreed on, by all the 

ICRAS agencies. OMB is then responsible for determining the expected 

loss rates associated with each ICRAS risk rating and maturity level. 

Overview of the ICRAS 

Framework 

ICRAS was formed to satisfy the requirement of the Federal Credit Reform 

Act of 1990 that common standards for country risk assessments be 

established for all U.S. government agencies and programs providing crossborder loans, guarantees, or insurance. OMB chairs ICRAS,1

 Ex-Im Bank 

serves as the secretariat, and several other agencies that undertake foreign 

lending serve as contributing members. Economists with Ex-Im Bank draft 

country papers that examine economic, political, and institutional 

variables. These papers present preliminary ratings on the 

creditworthiness of sovereign and nonsovereign borrowers in a country. 

These papers are sent to OMB, which distributes them to other ICRAS 

agencies for comment. Occasionally, agencies make major written 

comments indicating disagreement with an Ex-Im Bank–recommended 

rating. If the agency and Ex-Im Bank continue to disagree after discussion, 

OMB schedules a meeting of all ICRAS representatives to debate the 

unresolved issue(s). If there is no disagreement on its contents, or when 

agreement has been reached, the recommendations of a country paper 

1

The ICRAS working group is chaired by OMB and includes representatives from the crossborder financing agencies, including Ex-Im Bank, the Departments of Agriculture and 

Transportation, the Overseas Private Investment Corporation, the Agency for International 

Development, and the Defense Security Assistance Administration. Other interested 

government organizations, including the Departments of Treasury, State, and Commerce; 

the Federal Reserve; the Council of Economic Advisors; and the National Security Council 

are also represented. 

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Interagency Country Risk Assessment 

System 

become binding when OMB puts into effect the recommendations of a 

“group” of country papers. This occurs twice each year. 

Based on the results of this interagency process, OMB publishes two risk 

ratings for each country—a sovereign rating and a nonsovereign, or private, 

rating. Each sovereign borrower or guarantor is rated on an 11-category 

scale, ranging from A through F- - (or their numerical counterparts, 

categories 1-11). Category 1 (or A) is the most creditworthy and category 

11 (or F- -) is the least creditworthy. According to Ex-Im Bank, four 

categories, A through C-, are considered to be roughly equivalent to 

creditworthy private bond ratings. The bottom three categories, F through 

F- -, are used for countries that are insolvent or unwilling to make 

payments. Categories in-between represent various degrees of repayment 

difficulties. These ratings must be used in calculating the risk subsidy 

charged to each agency’s budget when it undertakes a foreign transaction. 

Each agency is free to set its own policies with respect to fees for different 

risk categories and cover policy (which specifies the risk levels at which it 

will undertake new business). 

Under credit reform, OMB is responsible for determining the expected loss 

rates associated with each ICRAS risk rating and maturity level. OMB 

provides updated expected loss rates to the ICRAS agencies for them to use 

each year in preparing budget submissions, calculating reestimates, and 

allocating subsidy costs during the fiscal year. 

Country Risk Assessments 	 In terms of extending export credits, country risks represent risks that 

threaten the repayment of obligations, apart from the financial viability of 

the transaction. In general terms, the degree of risk is measured as the 

product of the probability of payment delays and the probability of 

subsequent nonrecovery. A payment delay is any failure to make payments 

of principal or interest on original contract terms. Nonrecovery occurs in 

the event of default or debt forgiveness or when there are recurring or 

extended arrears. 

Sovereign transactions are those that carry the full faith and credit of the 

central government receiving the export credit. These would typically 

include transactions guaranteed by the Central Bank, Treasury, or Ministry 

of Finance. On a country-by-country basis, other institutions may also be 

designated as sovereign institutions, acting on behalf of the state. 

According to ICRAS documents, the ability of a country to service its 

foreign debt depends on the following major factors: foreign debt service 

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Interagency Country Risk Assessment 

System 

burden, the government’s ability to acquire foreign exchange to repay 

foreign obligations, macroeconomic environment, and political or social 

constraints. In addition to indicators reflecting those factors, ICRAS 

sovereign ratings are also based on ratings of private rating agencies and a 

group of Organization for Economic Cooperation and Development 

member countries, as well as information on a country’s payment arrears 

history with the United States and other foreign creditors. 

ICRAS ratings for private transactions in a country are based on qualitative 

and quantitative assessments of the depth of private sector business 

activity in a country and the strength of private sector institutions. In 

addition to factors related to vulnerability to foreign exchange crises, the 

ratings focus on a country’s banking system, legal system, foreign exchange 

availability, business climate, and political stability. They can be either 

higher or lower than ICRAS sovereign ratings. 

Page 78 GAO-04-531 Export-Import Bank 
Appendix V 

Credit Reform Budgeting


The Federal Credit Reform Act of 1990 required that budget authority to 

cover the cost to the government of new loans and loan guarantees (or 

modifications to existing credits) be provided before the credits are made. 

Credit reform requirements specified a net present value cost approach 

using estimates for future loan repayments and defaults as elements of the 

cost to be recorded in the budget. This permits policy makers to compare 

the costs of credit programs with each other and with noncredit programs 

in making budget decisions. 

The credit reform act defines the subsidy cost of direct loans as the present 

value of disbursements—over the loan’s life—by the government (loan 

disbursements and other payments) minus estimated payments to the 

government (repayments of principal, payments of interest, other 

recoveries, and other payments). It defines the subsidy cost of loan 

guarantees as the present value of cash flows from estimated payments by 

the government (for defaults and delinquencies, interest rate subsidies, and 

other payments) minus estimated payments to the government (for loan 

origination and other fees, penalties, and recoveries). 

Credit programs have a positive subsidy—that is, they lose money—when 

the present value of estimated payments by the government exceeds the 

present value of estimated receipts. Conversely, negative subsidy programs 

are those in which the present value of estimated collections is expected to 

exceed the present value of estimated payments; in other words, the 

programs make money (aside from administrative expenses.) 

The Federal Credit Reform Act of 1990 set up a special budget accounting 

system to record the budget information necessary to implement credit 

reform. It provides for three types of accounts to handle credit 

transactions. The program and financing accounts are used by credit 

obligations made since 1991. The program account receives appropriations 

for adminstrative and subsidy costs of a credit activity and is included in 

budget totals. When a direct loan or a loan guarantee is disbursed, the 

program account pays the associated subsidy cost for that loan to the 

financing account. The financing account, which is nonbudgetary, is used 

to record the cash flow associated with loans or loan guarantees over their 

Page 79 GAO-04-531 Export-Import Bank 
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Credit Reform Budgeting 

lives.

1

 It finances loan disbursements and the payments for loan guarantee 

defaults with (1) the subsidy cost payment from the program account, (2) 

loans from the Treasury, and (3) collections received by the government. 

Figure 8 diagrams this cash flow. 

Figure 8: Program and Finance Account Budgeting for Ex-Im Bank under Credit Reform 

Ex-Im Bank 

program account 

Financing 

account 

Funding sources Treasury 

Administrative 

cost 

Administrative 

cost 

Subsidy 

cost 

Subsidy cost 

Upward 

reestimates 

Upward reestimates 

Borrowing Repayments 

Payments 

for loan 

guarantee 

defaults 

Loan 

disbursements 

Collections 

(fees, 

principal/interest, 

recoveries from 

defaults) 

Receipt 

account 

Ex-Im Bank's annual 

budget authority 

Permanent/indefinite 

budget authority 

Downward 

reestimates 

Source: GAO analysis of credit reform guidance. 

Each year, as part of the President’s budget, agencies prepare estimates of 

the expected subsidy costs of new lending activity for the coming year. 

Agencies are also required to reestimate this cost annually. The Office of 

Management and Budget (OMB) has oversight responsibility for federal 

1

Nonbudgetary accounts may appear in the budget document for information purposes but 

are not included in the budget totals for budget authority or budget outlay. They do not 

belong in the budget, because they show only how something is financed and do not 

represent the use of resources. 

Page 80 GAO-04-531 Export-Import Bank 
Appendix V 

Credit Reform Budgeting 

credit program compliance with credit reform act requirements and also 

has responsibility for approving subsidy estimates and reestimates. In 

addition, for international credits extended by U.S. agencies, OMB provides 

agencies with specific guidance, including estimated defaults and 

recoveries by risk rating category, to be used in determining expected 

losses for financing activities. 

All credit programs automatically receive any additional budget authority 

that may be needed to fund reestimates. Thus, for discretionary programs, 

original subsidy cost estimates receive different budget treatment than 

subsidy cost reestimates.

2

 The original estimated subsidy cost must be 

appropriated as part of the annual appropriation process. However, upward 

reestimates of subsidy costs are financed from permanent indefinite budget 

authority and do not have to be appropriated in the annual appropriations 

process.3 

2

Discretionary programs are those controlled through the annual appropriations process. 

3

Permanent budget authority is available as the result of previously enacted legislation and 

does not require new legislation for the current year. Indefinite budget authority is budget 

authority of an unspecified amount. 

Page 81 GAO-04-531 Export-Import Bank 
Appendix VI 

Technical Description of OMB Model for 

Estimating Expected Loss of U.S. 

International Credit Activities 

The Office of Management and Budget (OMB) determines expected losses 

for international credit activities1

 through (1) a complex model that 

includes two estimates of default probabilities by ratings category and a 

rule for combining them and (2) an assumption about how much of the 

value of defaulted credits will be recovered. The default rate estimates use 

a statistical concept from finance literature that OMB terms “distance to 

default.” The first estimated relationship—the spread-default 

relationship—is between interest rate spreads on international bonds and 

historical default rates of corporate debt. The second estimated 

relationship—the ratings-default relationship—is between ratings on 

corporate debt and the historical default rates of that debt. Historical 

corporate default data are used in estimating both relationships. The model 

is structured so that the overall estimates of default for different ratings 

and maturities would be expected to be close to the underlying corporate 

default rates used. They will differ from the underlying historical default 

rates when interest rate spreads are higher or lower than their average over 

the historical period of the data used in the analysis. In addition, available 

information on the model suggests that there may be certain technical 

biases in the model’s forecasts. 

Distance to Default	 OMB’s modeling approach uses a mathematical concept called “distance to 

default,” a concept used in some finance models, which is a statistical 

representation of the safety of a credit. The statistical variable has an 

inverse relationship with default probability—the larger the distance to 

default, the smaller the probability of default. OMB’s model, in common 

with many models in academic finance journals, assumes that changes in 

this variable follow a normal statistical distribution, with a mean of zero, 

and that changes occur randomly with each time period. Using the 

assumption of a normal distribution, and given an estimated standard 

deviation, each distance to default implies a time pattern of annual default 

rates. Distance to default is estimated by finding the default cost implied by 

each distance to default and matching that cost to the prices at which 

bonds of a given rating are trading. 

Two forms of distance to default are used in the modeling effort. “Actual 

distance to default” relates to the actual probabilities of default. “Risk1

This description is based on our analysis of information that OMB provided about its 

current methodology as well as discussions with key OMB officials. We did not review any 

formal documentation of the methodology. 

Page 82 GAO-04-531 Export-Import Bank 
Appendix VI 

Technical Description of OMB Model for 

Estimating Expected Loss of U.S. 

International Credit Activities 

neutral distance to default,” which is related to interest rate spreads, refers 

to default rates (and recovery rates on defaulted credits) that are 

consistent with observed interest rates, assuming that interest rate spreads 

are attributed only to expected default costs. Finance theory attributes the 

difference between actual and risk-neutral distance to default to 

components of the interest rate beyond those that are related purely to 

default. For example, if lenders are risk averse, rather than risk neutral, 

they may need to be compensated with more than $1 of extra interest to 

bear a risk of loss that may, on average, be $1, but that may in some cases 

be substantially more. 

Given OMB’s estimated standard deviation of 3.79,

2 a default rate of 25 

percent for a 1-year bond implies an actual distance to default of 2.57. This 

can be calculated from a standard normal distribution table. Thus, for a 

given maturity, risk-free rate of interest, and standard deviation, knowledge 

of any of the following factors—spread, risk-neutral distance to default, or 

time pattern of default probabilities—allows the calculation of the other 

two factors. 

Spread-Default Relationship	 The spread-default relationship is an estimated relationship between 

interest rate spreads on international bonds and historical default rates of 

corporate debt, by rating and maturity. The relationship is structured so 

that its estimated default rates will be close to the historical default rates 

used when observed spreads are near their average levels and higher (or 

lower) than the historical default rates when spreads are higher (or lower) 

than average. 

The spread-default relationship is estimated with a regression that uses 

monthly observations on about 400 sovereign bonds and historical default 

rates on corporate bonds from Moody’s Investors Service. The dependent 

variable (the spread-related variable) is the risk-neutral distance to default, 

which is calculated as a function of the monthly interest rate spreads on the 

bonds in the sample. The independent variables are (1) the actual distance 

to default in historical data (the default-related variable), which is 

calculated for each rating and maturity as a function of the historical 

corporate default rates used, and (2) the remaining maturity of each bond. 

2

This is the standard deviation for the first year of the forecast. OMB's methodology for 

estimating the standard deviation is discussed later in this appendix. 

Page 83 GAO-04-531 Export-Import Bank 
Appendix VI 

Technical Description of OMB Model for 

Estimating Expected Loss of U.S. 

International Credit Activities 

The data used for the spread-related variable in the regression, the riskneutral distance to default, are Bloomberg’s monthly observations on 

foreign sovereign bonds, denominated in U.S. dollars and issued in 1987 or 

later.

3

 The spread on each monthly observation was calculated and 

transformed into an implied distance to default to be predicted by the 

regression. 

The key independent variable, based on a security’s rating, was calculated 

as follows: ratings from Moody’s and two other private ratings firms, 

Standard & Poor’s and Fitch Ratings, were linked to each monthly 

observation. The average rating4

 was calculated and used to link each 

observation to an independent variable, the actual distance to default, 

calculated as a function of historical default rates obtained from Moody’s. 

The remaining maturity of each bond, the second independent variable, 

was also taken from the Bloomberg data for each monthly observation. 

This spread-related variable, risk-neutral distance to default, is calculated 

by taking the spread on a bond of a given maturity and converting it to a 

risk-neutral expected loss. Specifically, the calculation determines the 

difference between the present value of the payments of the bond, 

assuming that the bond does not default, and the market price of the bond 

implied by the bond’s yield. The risk-neutral expected loss is turned into a 

risk-neutral expected default by solving an equation that relates expected 

loss to expected default rate. This equation calculates the present value of 

the losses implied by a series of default probabilities, where defaults are 

converted into a series of dollar losses by multiplying by a constant loss 

3

These bonds constitute the universe of foreign sovereign bonds from Bloomberg from 1987 

or later. According to OMB, observations where the difference between the price bid and the 

price asked for the bond (the bid-ask spread) of more than 10 basis points (for fiscal year 

2003) or 40 basis points (for fiscal year 2004) were eliminated because these observations 

may have been for illiquid instruments. This resulted in removing about half of the 

observations because of large differences between the bid and asked price for the bonds. 

This left 2,184 monthly observations. 

4

Rating categories are those of the nationally recognized statistical rating organizations, 

which are developed by the private sector and are widely available in financial reporting. 

OMB translates these ratings organizations’ ratings categories into ICRAS categories. 

Page 84 GAO-04-531 Export-Import Bank 
Appendix VI 

Technical Description of OMB Model for 

Estimating Expected Loss of U.S. 

International Credit Activities 

rate5 and the losses are discounted by the prevailing risk-free interest rate. 

Thus, a given standard deviation and a mean “distance to default” will 

generate a time pattern of default rates. This mean is chosen so that the 

present value of the implied dollar losses equals the risk-neutral expected 

loss. 

The default-related independent variable, actual distance to default, is 

calculated from Moody’s data on corporate defaults. Two Moody’s tables 

showing cumulative defaults by risk rating category and maturity were 

used, one for 1920-1999, and another for 1983-1999. The tables were 

combined into one table with a default rate for each combination, using the 

larger of the two default rates for each rating/maturity category. Missing 

table entries, or reversals (such as a higher-rated category having a higher 

default rate than the next lowest category) were handled by averaging table 

entries. A calculation similar to that for the dependent variable is made, 

finding a mean distance to default for each Moody’s rating category that 

will generate a time pattern of defaults similar to that in the Moody’s tables. 

Estimation of the regression produces the following parameters: 

Risk-neutral distance to default = -0.26 - 0.0074 * maturity + 0.73 * actual 

distance to default 

(Spread-related variable) (Default-related variable) 

The above relationship is then inverted to produce a forecast of the defaultrelated variable, based on the value of the spread-related variable, resulting 

in the following equation: 

Actual distance to default = (0.26/0.73) + (0.0074/0.73) * maturity + 

(1/0.73) * risk-neutral distance to default 

An autoregressive parameter is estimated from the residuals of the above 

regression. This parameter is used to estimate a set of weights for 

combining distance to default estimates. For every observed month, each 

bond has a spread and maturity—hence, a predicted actual distance to 

default. The predicted actual distance to default for each bond/month is 

5

OMB used an “investor loss rate” for this calculation, which OMB said differed from the 

U.S. government loss rates (or recovery rates) it used to transform its final estimates of 

default rates into expected loss rates. According to OMB, the investor loss rate it used was 

based on the market prices of F- - (F double minus) credits. 

Page 85 GAO-04-531 Export-Import Bank 
Appendix VI 

Technical Description of OMB Model for 

Estimating Expected Loss of U.S. 

International Credit Activities 

averaged to produce an estimated distance to default for that bond. The 

weights, derived from the autoregressive parameter, are used to construct 

the weighted average. The weights are calculated so that more recent 

months have more weight when taking the average. 

The actual distance to default predicted by this regression depends on the 

interest spread on each bond relative to the average spread for its rating 

category in the Bloomberg data used in the analysis. If the spread on a 

particular bond is larger than the historical average spread in the database, 

then the predicted actual distance to default will be smaller than the 

historical average.

6

 This would imply that the projected defaults will be 

larger than the historical average, because projected defaults move 

inversely with distance to default. Because this part of the OMB model 

bases default risk on a mixture of both current spreads and past spreads, 

default risk estimates will change more slowly than will the market 

assessment of risk, as reflected in changes in interest rate spreads. 

Rating-Default Relationship	 The relationship between ratings on corporate debt and the historical 

default rates of that debt is estimated using the Moody’s corporate default 

tables described above. The relationship is structured so that it predicts 

cumulative default rates by ratings category and maturity that are almost 

exactly the same as those in the combined Moody’s tables. As with the 

spread-default relationship, it is assumed that distance to default is a 

normally distributed variable whose mean and standard deviation 

corresponds to a pattern of defaults over time. A mean for each rating 

category is estimated, along with a common standard deviation for all 

rating categories, that minimizes the sum of squared errors between the 

cumulative default rates predicted by the means and standard deviation 

and the actual data contained in the Moody’s corporate default database. A 

different standard deviation is estimated for the first year than for 

subsequent years. This allows the actual distance to default for any given 

bond in a rating category to differ from the average distance to default for 

all bonds within a rating category, in addition to allowing a bond’s distance 

to default to change over time. 

6

In regression analysis, when the independent variables are at their mean values, the 

dependent variable will be at its mean value. Conversely, if a bond is near the average of the 

spreads observed in the data, then the predicted actual distance to default will be close to 

the average observed in the Moody’s data. 

Page 86 GAO-04-531 Export-Import Bank 
Appendix VI 

Technical Description of OMB Model for 

Estimating Expected Loss of U.S. 

International Credit Activities 

Aggregating the Estimates	 The estimated actual distances to default for each bond from the spreaddefault relationship are averaged together so that there is one estimated 

distance to default for each rating category. The estimated mean distance 

to default for each rating category obtained from the spread data is then 

combined with the estimated mean distance to default from the rating data. 

A Bayesian (type of statistical) weighting scheme is used, giving more 

weight to the spread-default relationship. According to OMB, weights vary 

by rating category, but generally a weight of about two-thirds is given to the 

spread-default relationship and a weight of about one-third is given to the 

rating-default relationship. 

The result is a single actual distance to default number for each rating 

category. This average value, combined with the common estimated 

standard deviation for all ratings, is used to estimate annual default rates 

for each rating category. An illustration of how spread changes can affect 

OMB’s final default estimates is shown in figure 9. 

Figure 9: Illustration of How Spread Changes Can Affect the Final Expected Default 

Estimates 

1-year 

bond 

Change in spread 

Increase in expected 

default probability 

From 5% to 6% 

From 10% to 11% 

(1 percentage point) 

(1 percentage point) 

<36 basis points 

<57 basis points 

Example 1: 

Example 2: 

Two hypothetical examples, representing two data points and based on several assumptions, illustrate 

how spreads affect expected defaults in the OMB model. First, for a particular 1-year bond, according to 

the spread-default equation, a change in the spread of 1 percentage point (or 100 basis points) from 5 

percent to 6 percent would increase the default probability estimated from the spread-default 

relationship from 1.4 percent to 1.9 percent. The actual effect in that estimation would be smaller, 

depending on how much weight is given to recent spread observations compared with earlier ones. 

Averaging this effect with the outcome of the ratings-default relationship, which is fixed, reduces the 

impact by about one-third. Thus, depending on specific model specifications, this 1 percentage point 

increase in the spread would be expected to increase expected default, for that one observation, by 

something less than 36 basis points (assuming that the rating itself has not changed). 

The nonlinear form of the model causes the change in default probabilities for a given change in 

spreads to vary depending on the levels of the initial spreads and default probabilities. A similar exercise 

for a 1-percentage-point increase in the interest rate spread from 10 to 11 percent, for one data point, 

yields an increase in the default probability for that data point of some amount less than 57 basis points. 

Source: GAO. 

Page 87 GAO-04-531 Export-Import Bank 
Appendix VI 

Technical Description of OMB Model for 

Estimating Expected Loss of U.S. 

International Credit Activities 

Recovery Rates	 To derive expected loss rates for each risk and maturity category from the 

expected default rates generated by the model, OMB uses an assumption 

about the percentage of defaulted credits that will be recovered. According 

to OMB, a common recovery rate of 17 percent was used for fiscal year 

2003, a common recovery rate of 12 percent was used for fiscal year 2004, 

and a common recovery rate of 9 percent was used for fiscal year 2005. 

Observations on Potential 

Technical Limitations of the 

Model 

Available information on the model suggests several potential technical 

limitations, including the following: 

•	 The independent variable in the regression, actual distance to default, 

may be measured with error. The model assumes that a particular 

observation may have a distance to default that is different from the 

average implied by the rating category. Additionally, the distance to 

default implied by the rating category does not change over time, while 

risk may change over time, even within a rating category. Measurement 

error in an independent variable generally results in a downward bias in 

the coefficient for that variable.

7

 When the estimated relationship is 

reversed so that spreads are used to predict default rates, as in the OMB 

model, this bias will affect the projected default rates. 

•	 As noted, the actual distance to default implied by a rating category 

remains constant over time, while the risk neutral distance to default, 

implied by the interest rate spreads on bonds, changes over time. Thus, 

the regression uses the relationship between spreads and defaults 

across rating categories to produce an estimated coefficient. This 

coefficient is then used to estimate default probabilities for a given 

rating category, which change over time. The supporting documentation 

for the model does not demonstrate a correspondence between changes 

in default probability over time within a rating category and changes in 

default probability across rating categories. 

•	 A regression is designed to predict the dependent variable in such a way 

that the squared errors in the prediction of the dependent variable are 

7

See Peter Kennedy, A Guide to Econometrics, 4th ed. (Cambridge, MA: The MIT Press, 

1998), 140-142 and 148. In the case of one independent variable, measurement error always 

leads to a downward bias. With more than one independent variable, the analysis more 

complicated. See M. Levi, “Errors in Variables Bias in the Presence of Correctly Measured 

Variables,” Econometrica vol. 41, #5 (September 1973). 

Page 88 GAO-04-531 Export-Import Bank 
Appendix VI 

Technical Description of OMB Model for 

Estimating Expected Loss of U.S. 

International Credit Activities 

minimized. Using the regression to predict the risk-neutral distance to 

default and then inverting the estimated relationship to predict actual 

distance to default may result in greater errors in the projected 

distances to default than estimating the regression with actual distance 

to default as the dependent variable. 

•	 The relationships between risk-neutral distance to default and the two 

independent variables—actual distance to default and maturity—may 

not be linear. If this is the case, then spreads might provide an adequate 

forecast of default probabilities near the means of the Bloomberg data 

set used in the regression but not for values of spreads that depart from 

the mean spread in the regression data. This issue could be important 

for the reliability of estimates for credits with ratings several categories 

below the average in the Bloomberg data. With sufficient data, the 

potential for quantitatively important nonlinearities can be assessed by 

estimating alternative specifications, such as including the squares and 

cross-products of the independent variables. 

Page 89 GAO-04-531 Export-Import Bank 
Appendix VII 

Comparison of OMB Default Probabilities for 

Fiscal Years 2004 and 2005 with Corporate 

Default Rates Used in OMB Model 

In fiscal year 2003, the Office of Management and Budget (OMB) 

introduced its current methodology for estimating the expected loss rates 

of international financing provided by U.S. credit agencies. This 

methodology is used to estimate loss rates for 8 of the 11 risk-rating 

categories established by the Interagency Country Risk Assessment System 

(ICRAS). 

OMB’s methodology includes two components that are used to estimate 

default probabilities by ICRAS rating category. One component uses default 

rates for corporate bonds published in 2000 by a nationally recognized 

private rating agency, Moody’s Investors Service, to calculate the 

probability that ICRAS agency borrowers will default. It estimates default 

probabilities for each ICRAS rating category by using one or more 

underlying Moody’s risk category. The other component uses data on 

interest rate differences, or spreads, to vertically adjust the Moody’s 

corporate default rates by rating category when interest rate spreads are 

unusually high or low relative to average spreads in that rating category. 

Once it has determined default probabilities by ICRAS rating category, the 

methodology applies a recovery rate assumption to derive expected loss 

rates by rating category. 

We compared the default probabilities underlying OMB’s fiscal year 2004 

and 2005 expected loss rates for ICRAS categories 1 through 8 with the 

Moody’s corporate default data that OMB used in estimating these rates. 

We determined that the OMB default probabilities were lower for each 

ICRAS rating category in both fiscal years than were the underlying 

Moody’s default rates. Figures 10 through 17 compare OMB’s default 

probabilities for fiscal years 2004 and 2005 in a given ICRAS rating category 

with the Moody’s corporate default rates used in OMB’s model that 

correspond to each rating category. The figures show that the OMB default 

rates were generally similar in fiscal years 2004 and 2005, with somewhat 

lower rates in 2005 for certain ICRAS categories. 

Page 90 GAO-04-531 Export-Import Bank 
Appendix VII 

Comparison of OMB Default Probabilities for 

Fiscal Years 2004 and 2005 with Corporate 

Default Rates Used in OMB Model 

Figure 10: Comparison of OMB Default Probabilities for Fiscal Years 2004 and 2005 

for ICRAS Category 1 with Moody’s Corporate Default Rates Used in OMB Model 

Percentage default rate or probability 

50 1.5 

45 1.2 

40 

.9 

35 

.6 

30 

25 .3 

20 0 1 2 3 4 5 6 7 8 

15 

10 

5 

0 

1 2 3 4 5 6 7 8 

Years to maturity 

Corporate default rates used in OMB model 

FY 2005 OMB default probability 

FY 2004 OMB default probability 

Source: GAO analysis of OMB data. 

Page 91 GAO-04-531 Export-Import Bank 
Appendix VII 

Comparison of OMB Default Probabilities for 

Fiscal Years 2004 and 2005 with Corporate 

Default Rates Used in OMB Model 

Figure 11: Comparison of OMB Default Probabilities for Fiscal Years 2004 and 2005 

for ICRAS Category 2 with Moody’s Corporate Default Rates Used in OMB Model 

Percentage default rate or probability 

50 

45 

40 

35 

30 

25 

20 0 

.5 

1.0 

1.5 

2.0 

2.5 

3.0 

1 2 3 4 5 6 7 8 

15 

10 

5 

0 

1 2 3 4 5 6 7 8 

Years to maturity 

Corporate default rates used in OMB model 

FY 2005 OMB default probability 

FY 2004 OMB default probability 

Source: GAO analysis of OMB data. 

Page 92 GAO-04-531 Export-Import Bank 
Appendix VII 

Comparison of OMB Default Probabilities for 

Fiscal Years 2004 and 2005 with Corporate 

Default Rates Used in OMB Model 

Figure 12: Comparison of OMB Default Probabilities for Fiscal Years 2004 and 2005 

for ICRAS Category 3 with Moody’s Corporate Default Rates Used in OMB Model 

Percentage default rate or probability 

50 

45 

40 

35 

30 

25 

20 0 

1 

2 

3 

4 

5 

1 2 3 4 5 6 7 8 

15 

10 

5 

0 

1 2 3 4 5 6 7 8 

Years to maturity 

Corporate default rates used in OMB model 

FY 2005 OMB default probability 

FY 2004 OMB default probability 

Source: GAO analysis of OMB data. 

Page 93 GAO-04-531 Export-Import Bank 
Appendix VII 

Comparison of OMB Default Probabilities for 

Fiscal Years 2004 and 2005 with Corporate 

Default Rates Used in OMB Model 

Figure 13: Comparison of OMB Default Probabilities for Fiscal Years 2004 and 2005 

for ICRAS Category 4 with Moody’s Corporate Default Rates Used in OMB Model 

Percentage default rate or probability 

50 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0 

1 2 3 4 5 6 7 8 

Years to maturity 

Corporate default rates used in OMB model 

FY 2005 OMB default probability 

FY 2004 OMB default probability 

Source: GAO analysis of OMB data. 

Page 94 GAO-04-531 Export-Import Bank 
Appendix VII 

Comparison of OMB Default Probabilities for 

Fiscal Years 2004 and 2005 with Corporate 

Default Rates Used in OMB Model 

Figure 14: Comparison of OMB Default Probabilities for Fiscal Years 2004 and 2005 

for ICRAS Category 5 with Moody’s Corporate Default Rates Used in OMB Model 

Percentage default rate or probability 

50 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0 

1 2 3 4 5 6 7 8 

Years to maturity 

Corporate default rates used in OMB model 

FY 2005 OMB default probability 

FY 2004 OMB default probability 

Source: GAO analysis of OMB data. 

Page 95 GAO-04-531 Export-Import Bank 
Appendix VII 

Comparison of OMB Default Probabilities for 

Fiscal Years 2004 and 2005 with Corporate 

Default Rates Used in OMB Model 

Figure 15: Comparison of OMB Default Probabilities for Fiscal Years 2004 and 2005 

for ICRAS Category 6 with Moody’s Corporate Default Rates Used in OMB Model 

Percentage default rate or probability 

50 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0 

1 2 3 4 5 6 7 8 

Years to maturity 

Corporate default rates used in OMB model 

FY 2005 OMB default probability 

FY 2004 OMB default probability 

Source: GAO analysis of OMB data. 

Page 96 GAO-04-531 Export-Import Bank 
Appendix VII 

Comparison of OMB Default Probabilities for 

Fiscal Years 2004 and 2005 with Corporate 

Default Rates Used in OMB Model 

Figure 16: Comparison of OMB Default Probabilities for Fiscal Years 2004 and 2005 

for ICRAS Category 7 with Moody’s Corporate Default Rates Used in OMB Model 

Percentage default rate or probability 

50 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0 

1 2 3 4 5 6 7 8 

Years to maturity 

Corporate default rates used in OMB model 

FY 2005 OMB default probability 

FY 2004 OMB default probability 

Source: GAO analysis of OMB data. 

Page 97 GAO-04-531 Export-Import Bank 
Appendix VII 

Comparison of OMB Default Probabilities for 

Fiscal Years 2004 and 2005 with Corporate 

Default Rates Used in OMB Model 

Figure 17: Comparison of OMB Default Probabilities for Fiscal Years 2004 and 2005 

for ICRAS Category 8 with Moody’s Corporate Default Rates Used in OMB Model 

Percentage default rate or probability 

50 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0 

1 2 3 4 5 6 7 8 

Years to maturity 

Corporate default rates used in OMB model 

FY 2005 OMB default probability 

FY 2004 OMB default probability 

Source: GAO analysis of OMB data. 

Page 98 GAO-04-531 Export-Import Bank 
Appendix VIII 

Trends in Interagency Country Risk 

Assessment System Expected Loss Rates 

Through the Interagency Country Risk Assessment System (ICRAS), the 

Office of Management and Budget (OMB) annually provides expected loss 

rates to ICRAS agencies to use in preparing their budget submissions and 

subsidy cost estimates. The expected loss rates, issued for each of the 11 

ICRAS risk categories, have changed in percentage terms over time. Figure 

18 shows the trends in expected loss rates for ICRAS categories 1 through 8 

for credits of 8-year maturity, expressed in present value terms, for fiscal 

years 1997 through 2005.1 

1

During the period analyzed, the format in which OMB presented expected loss rates varied. 

For fiscal years 1997 through 2002, OMB presented risk premiums for ICRAS categories 1 

through 8, which were grouped into several maturity bands. From these premiums, an 

expected loss rate could be derived. Beginning in fiscal year 2003, OMB changed its 

presentation into expected loss rates for ICRAS categories 1 through 8, across different 

maturities. To show trends over time, we converted the risk premiums into expected loss 

rates. 

Page 99 GAO-04-531 Export-Import Bank 
Appendix VIII 

Trends in Interagency Country Risk 

Assessment System Expected Loss Rates 

Figure 18: Trends in ICRAS Expected Loss Rates for 8-Year Maturity Credits, in Present Value Terms, Fiscal Years 1997-2005 

Percentage expected loss 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0 

1997 1998 1999 2000 2001 2002 2003 2004 2005 

Fiscal year 

8 

7 

6 

5 

4 

3 

2 

1 

# ICRAS score 

Source: GAO analysis of OMB expected loss rates. 

Note: The present values were calculated for credits of 8-year maturity using OMB’s credit subsidy 

calculator based on a discount rate of 5 percent in each fiscal year. 

Page 100 GAO-04-531 Export-Import Bank 
Appendix IX 

Comments from the Office of Management 

and Budget 

Page 101 GAO-04-531 Export-Import Bank 
Appendix IX


Comments from the Office of Management


and Budget


Page 102 GAO-04-531 Export-Import Bank 
Appendix X 

GAO Contacts and Staff Acknowledgments


GAO Contacts	 Celia Thomas, 202-512-8987 

Shirley Brothwell, 202-512-3865 

Staff 	 In addition to those individuals named above, Allison Abrams, Nathan 

Anderson, Dan Blair, Patrick Dynes, Reid Lowe, Ernie Jackson, Austin Acknowledgments 	 Kelly, Bruce Kutnick, Berel Spivack, and Roger Stoltz made major 

contributions to this report. 

(320161) Page 103 GAO-04-531 Export-Import Bank 
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