Export-Import Bank: Recent Growth Underscores Need for Continued Improvements in Risk Management
Released: 2013-03-28T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: Ex-Im helps U.S. firms export goods and services by providing a range of financial products. The Export-Import Bank Reauthorization Act of 2012 increased the statutory ceiling on the agency's total exposure to $140 billion in 2014. The act also requires GAO to evaluate Ex-Im's growth and the effectiveness of its risk management. This report discusses (1) how Ex-Im's business changed in recent years and possible reasons for these changes; (2) how Ex-Im determines credit subsidy costs, loss reserves and allowances, and product fees, and how these processes account for different risks; (3) how Ex-Im's financial portfolio has performed and the budgetary impact of its programs; and (4) the extent to which Ex-Im has a comprehensive risk-management framework. To address these objectives, GAO analyzed Ex-Im's financial data, policies and procedures, and processes for calculating program costs and loss reserves. GAO also interviewed Ex-Im officials and other entities involved in export financing.

section_title: What GAO Found
paragraphs: From fiscal year 2008 to fiscal year 2012, the U.S. Export-Import Bank's (Ex-Im) outstanding financial commitments (exposure) grew from about $59 billion to about $107 billion, largely in long-term loans and guarantees. Factors associated with this growth include reduced private-sector financing following the financial crisis and Ex-Im's authorization of direct loans--a product not offered by export credit agencies in some other countries--to fill the gap in private-sector lending.

Ex-Im's processes for determining credit subsidy costs, loss reserves and allowances, and fees account for multiple risks. To implement the Federal Credit Reform Act of 1990 and other requirements, Ex-Im calculates subsidy costs and loss reserves and allowances with a loss model that uses historical data and takes credit, political, and other risks into account. Consistent with industry practices, Ex-Im added factors to the model in 2012 to adjust for circumstances that may cause estimated credit losses to differ from historical experience. Opportunities exist to further improve the model. For example, Ex-Im uses a 1-year forecast of certain bond defaults to predict possible changes in loss estimates from changed economic conditions. However, a short-term forecast may not be appropriate for adjusting estimated defaults for longer-term products. Ex-Im's fees are generally risk-based and, for medium- and long-term products (about 85 percent of Ex-Im's exposure), guided by international agreements that set minimum fees that account for credit and political risk.

As of December 2012, Ex-Im reported an overall default rate of less than 1 percent. However, Ex-Im has not maintained data needed to compare the performance of newer books of business with more seasoned books at comparable points in time, a type of analysis recommended by federal banking regulators. Also, without point-in-time data showing when defaults occur, the precision of Ex-Im's loss model may be limited. Ex-Im has been self-sustaining since 2008 and has generated receipts for the government. But, because Ex-Im's portfolio contains a large volume of recent transactions, the long-term impact of this business on default rates and the federal budget is not yet known.

Ex-Im has been developing a more comprehensive risk-management framework but faces operational risks. Ex-Im manages credit and other risks through transaction underwriting, monitoring, and restructuring. Ex-Im also started addressing recommendations by its Inspector General (IG) about portfolio stress testing, thresholds for managing portfolio concentrations, and risk governance. GAO’s review of internal control standards and industry practices indicates that the IG’s recommendations represent promising techniques that merit continued attention. Ex-Im has not yet made plans to report its stress test scenarios and results to Congress, although doing so would aid congressional oversight and be consistent with internal control standards for effective external communication. Ex-Im faces potential operational risks because the growth in its business volume has strained the capacity of its workforce. Ex-Im has determined that it needs more staff, but it has not formally determined the level of business it can properly manage. GAO internal control standards state that agencies should develop a risk-management approach based on how much risk can be prudently accepted. Without benchmarks to determine when workload levels have created too much risk, Ex-Im’s ability to manage its increased business volume may be limited.

section_title: What GAO Recommends
paragraphs: Ex-Im should (1) assess whether it is using the best available data for adjusting the loss estimates for longer-term transactions to account for global economic risk, (2) retain point-in-time performance data to compare the performance of newer and older business and to enhance loss modeling, (3) report stress testing scenarios and results to Congress, and (4) develop benchmarks to monitor and manage workload levels. Ex-Im agreed with each of these recommendations.

section_title: Letter
paragraphs: The U.S. Export-Import Bank (Ex-Im) helps U.S. firms export goods and  services by providing a range of financial products including direct loans,  loan guarantees, and insurance, particularly during times of economic  crisis when private financing is not available. In the wake of the 2007- 2009 financial crisis, Ex-Im’s business volume grew substantially,  reaching about $36 billion in new authorizations in 2012. Additionally, in  May 2012, Congress enacted the Export-Import Bank Reauthorization Act  of 2012 that increased the agency’s exposure limit—that is, the total  outstanding value of all direct loans, loan guarantees, and insurance  policies that Ex-Im cannot exceed—from $100 billion in 2011 to $140  billion in 2014. As of the end of 2012, Ex-Im’s total exposure was about  $107 billion.

Ex-Im’s charter requires the transactions the agency authorizes to have a  reasonable assurance of repayment. To comply with this requirement, Ex- Im must manage the wide variety of risks associated with providing export  financing. The recent growth in Ex-Im’s exposure has heightened interest  in ensuring that Ex-Im has proper controls in place to minimize these risks  while meeting the needs of U.S. exporters. Furthermore, a report issued  in September 2012 by Ex-Im’s Inspector General (IG) identified  weaknesses in Ex-Im’s risk-management policies and procedures and  made several recommendations for improvement. As with any credit  institution, Ex-Im expects that some portion of the credit it offers will not  be repaid, and it estimates these future losses to establish loss reserves  and allowances reported in its financial statements and to comply with  federal budgeting requirements in the Federal Credit Reform Act of 1990  (FCRA). FCRA requires that before entering into direct loans or loan  guarantees, Ex-Im must have budget authority for its “credit subsidy  costs”—broadly speaking, estimates of net losses on a present value  basis, excluding administrative costs. Ex-Im collects fees and, if  applicable, interest payments from obligors, which (among other cash  flows) are incorporated into estimates of credit subsidy costs.

The Export-Import Bank Reauthorization Act of 2012 required GAO to  evaluate Ex-Im’s growth and the effectiveness of its risk management.  This report discusses: (1) how Ex-Im’s business changed in recent years  and possible reasons for these changes; (2) how Ex-Im determines credit  subsidy costs, loss reserves and allowances, and product fees, and how  these processes account for different risks; (3) how Ex-Im’s financial  portfolio has performed and the budgetary impact of its programs; and (4)  the extent to which Ex-Im has a comprehensive risk-management  framework.

To address these objectives, we reviewed a range of data and  documentation and interviewed officials from Ex-Im and other  organizations involved in credit financing. More specifically, to examine  changes in Ex-Im’s business, we analyzed data on Ex-Im’s financial  exposure from 1990 through 2012 and authorizations from 2006 through  2012. To identify possible reasons for trends in Ex-Im’s business activity,  we reviewed a variety of Ex-Im documents—including the agency’s  annual reports, competitiveness reports, and strategic plan—and  analyzed data on global credit market conditions. We also interviewed Ex- Im officials, representatives of industry trade associations and research  organizations, and officials from the export credit agencies (ECA) of  Canada, France, Japan, and the United Kingdom.

To examine how Ex-Im determines subsidy costs, loss reserves and  allowances, and product fees, and how these processes account for  different risks, we reviewed relevant requirements and guidance,  including FCRA, Office of Management and Budget (OMB) Circular No.  A-11, and federal financial accounting guidance. We examined  information on the tools and processes Ex-Im uses to determine subsidy  costs and loss reserves and allowances, including Ex-Im’s loss estimation  model, and interviewed Ex-Im officials about their implementation. We  also reviewed international agreements that govern fees charged by  ECAs and reviewed Ex-Im analyses used to support fee adjustments.  Further, we interviewed officials from the four foreign ECAs cited  previously and officials from other selected U.S. federal credit agencies  about their practices for estimating costs, reserving for losses, and setting  fees.

To assess how Ex-Im’s financial portfolio has performed and the  budgetary impact of its programs, we analyzed Ex-Im’s default rates by  product type and for the portfolio as a whole. We examined end-of-fiscal- year data for 2006 through 2012 and data as of December 31, 2012. We  also reviewed federal banking regulator guidance on monitoring default  rates. Additionally, we examined an Ex-Im analysis of the funds it  received and sent to the Department of the Treasury (Treasury) from  1990 through 2012. We reviewed supporting information in appropriation  acts, the President’s budgets, and Ex-Im’s financial statements for the  same years and determined Ex-Im’s analysis was reasonable.

To assess the extent to which Ex-Im has a comprehensive risk- management framework, we reviewed Ex-Im’s practices for managing  risks at the transaction and portfolio levels. We reviewed a 2012 report by  the Ex-Im IG on portfolio risk management and determined what actions  Ex-Im had taken in response to the report’s recommendations. We also  identified relevant criteria in our internal control standards and from  practices identified by financial industry groups. In addition, we reviewed  information related to potential operational risks stemming from trends in  Ex-Im’s business volume and workload. We limited our work in this area  to Ex-Im’s human capital management. We analyzed Ex-Im data on the  number of full-time equivalents (FTE) and the number and dollar volume  of transactions authorized from 2006 through 2012. Additionally, we  interviewed Ex-Im officials, foreign ECA officials, and officials from other  federal credit agencies about risk-management practices. To assess the  reliability of the data we used, we reviewed information related to data  elements and controls, performed electronic testing for obvious errors in  accuracy and completeness, compared data to published documents, and  interviewed knowledgeable officials about the data. We concluded that  the data elements we used were sufficiently reliable for purposes of  describing Ex-Im’s growth, financial performance, and workload.  Appendix I provides more information on our scope and methodology.

We conducted this performance audit from June 2012 to March 2013 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
subsections: section_title: Ex-Im’s Mission, Financing Products, and Risks
paragraphs: Ex-Im, the official ECA of the United States, is an independent agency  operating under the Export-Import Bank Act of 1945, as amended. Its  mission is to support the export of U.S. goods and services overseas,  thereby supporting U.S. jobs. Official ECAs are organizations that provide  export credits with explicit government backing, where either the  government or the government-owned ECA assumes all or a portion of  the risk. Export credits are financing arrangements designed to mitigate  risks to buyers and sellers associated with international transactions.  Buyers and sellers in international transactions face unique risks, such as  foreign exchange risk, difficulties in settling disputes when damages to  shipments occur, or instability in the buyer’s country. For these reasons,  private lenders may be reluctant to finance a buyer’s purchase of foreign  goods or finance a seller’s operations. Export credit products are meant  to facilitate international transactions by mitigating these risks.

An international agreement, the Organisation for Economic Cooperation  and Development (OECD) Arrangement on Officially Supported Export  Credits (the OECD Arrangement), governs various aspects of U.S. and  other member countries’ ECAs. The OECD Arrangement aims to provide  a framework for the use of officially supported export credits; promote a  level playing field, where competition is based on the price and quality of  the exported goods and not the financial terms provided; and provide  transparency over programs and transactions. For example, the OECD  arrangement sets minimum transaction fees. Participants include  Australia, Canada, the European Union, Japan, South Korea, New  Zealand, Norway, Switzerland, and the United States. The OECD  Arrangement applies to officially supported export credits with repayment  terms of 2 years or more.

Congress has placed specific requirements on Ex-Im’s operations. For  example, Ex-Im’s charter states that it should not compete with the  private sector. Rather, Ex-Im’s role is to assume the credit and country  risks that the private sector is unable or unwilling to accept. In addition,  Ex-Im must submit annual reports to Congress on its actions to provide  financing on a competitive basis with other ECAs, and to minimize  competition in government-supported export financing. Furthermore, Ex- Im must make available at least 20 percent of its authorized aggregate  loans, loan guarantees, and insurance (export financing) each fiscal year  for the direct benefit of small businesses. Congress also has given Ex-Im  instructions on the share of its financing for environmentally beneficial  exports, including renewable energy, and to expand the promotion of its  financing in sub-Saharan Africa.

Ex-Im offers a number of export financing products, including direct loans,  loan guarantees, and export credit insurance. Ex-Im makes fixed-rate  loans directly to international buyers of goods and services. These loans  can be short-term (up to 1 year), medium-term (more than 1 year up to 7  years), or long-term (more than 7 years). Ex-Im also guarantees loans  made by private lenders to international buyers of goods or services,  promising to pay the lenders if the buyers default. Like direct loans, loan  guarantees may be short-, medium-, or long-term. Additionally, Ex-Im  provides export credit insurance products that protect the exporter from  the risk of nonpayment by foreign buyers for commercial and political  reasons. This allows U.S. exporters the ability to offer foreign purchasers  the opportunity to make purchases on credit. Credit insurance policies  can cover a single buyer or multiple buyers and can be short- or medium- term. Insurance policies are also available to cover lenders and exporters  that finance purchases by foreign buyers. Ex-Im’s short-term insurance  covers a wide range of goods, raw materials, spare parts, components,  and most services on terms up to 180 days. Medium-term insurance  policies protect longer-term financing to international buyers of capital  equipment or services, covering one or a series of shipments. Financing  under medium-term insurance policies generally can extend up to 5  years.

Some of Ex-Im’s short-term products are geared toward U.S. small  businesses that have the potential to export but lack sufficient funds to  support export efforts and include direct loans and loan guarantees to  provide these businesses with working capital. Working capital loans are  fixed-rate loans that provide exporters with 6- or 12-month revolving lines  of credit. Working capital guarantees generally cover 90 percent of the  principal and interest on a loan made to an exporter by a private lender.  The guarantees are typically 1 year, but can extend up to 3 years and be  used on a single transaction or on a revolving basis. Ex-Im delegates the  authority for underwriting most of these transactions directly to Ex-Im- approved private-sector lenders.

Ex-Im’s long-term products are often used in project finance transactions,  what Ex-Im terms “structured finance” transactions, and aircraft  transactions. These transactions involve complicated financing  arrangements, and Ex-Im has separate divisions to handle them. These  transactions also generally involve a direct loan or loan guarantee and  their value is usually greater than $10 million. Project finance is an  arrangement in which Ex-Im lends to newly created project companies in  foreign countries and looks to the project’s future cash flows as the  source of repayment instead of relying directly on foreign governments,  financial institutions, or established corporations for repayment of the  debt. The projects involve a large number of contracts for completion and  operation. Project finance transactions have repayment terms up to 14  years (18 years for renewable energy transactions) and typically include  the financing of development of a new facility in a foreign country, such as  a factory or power plant, or significant facility or production expansions.  Most of Ex-Im’s project finance transactions have been oil and gas and  power sector projects. In structured finance transactions, Ex-Im provides  direct loans or loan guarantees to existing companies located overseas  based on these companies’ balance sheets plus credit enhancements,  such as escrow or reserve accounts, subject to Ex-Im’s control; special  insurance requirements; and letters of credit pledged to Ex-Im through a  bank or other third party. Structured finance transactions generally have  repayment terms of 10 years (12 years for power transactions). Among  others, Ex-Im has completed structured transactions for oil and gas  projects and air traffic control, telecommunications, and manufacturing  entities. Finally, Ex-Im provides long-term direct loans and loan  guarantees that support the purchase of aircraft. Ex-Im uses external  advisers to assist in arranging project finance, structured finance, and  aircraft transactions. These advisers can include financial, legal,  technical, insurance, market, and environmental consultants.

Ex-Im faces multiple risks when it extends export credit financing. These  risks include credit, political, market, concentration, foreign-currency, and  operational risks, which are defined as follows:

Credit risk. The risk that an obligor may not have sufficient funds to  service its debt or be willing to service its debt even if sufficient funds  are available.

Political risk. The risk of nonrepayment resulting from expropriation of  the obligor’s property, war, or inconvertibility of the obligor’s currency  into U.S. dollars.

Market risk. The risk of loss from declining prices or volatility of prices  in the financial markets. Market risk can arise from shifts in  macroeconomic conditions, such as productivity and employment, and  from changes in expectations about future macroeconomic conditions.

Concentration risk. Risk stemming from the composition of a credit  portfolio. Concentration risk comes into being through an uneven  distribution of credits within a portfolio. Ex-Im faces three types of  concentration risk: Industry concentration. The risk that events could negatively affect  not only one obligor but also many obligors in the same industry  simultaneously.

Geographic concentration. The risk that events could negatively  affect not only one obligor but many obligors simultaneously  across a country or region.

Obligor concentration. The risk that defaults from a small number  of obligors will have a major adverse impact on the portfolio  because they account for a large share of the portfolio.

Foreign-currency risk. The risk of loss as a result of appreciation or  depreciation in the value of a foreign currency in relation to the U.S.  dollar in Ex-Im transactions denominated in that foreign currency.

Operational risk. The risk of loss resulting from inadequate or failed  internal processes, people, and systems, or from external events.

section_title: Budgetary Treatment of Federal Credit Programs
paragraphs: In 1990, to more accurately measure the cost of federal credit programs,  Congress enacted FCRA, which requires agencies that provide domestic  or international credit, including Ex-Im, to estimate and request  appropriations for the long-term net losses, or subsidy costs, of their  credit activities. Credit programs incur subsidy costs when estimated  payments by the government (such as loan disbursements or claims paid  on defaulted loans) exceed estimated payments to the government (such  as principal repayments, fees, interest payments, and recoveries), on a  net present value basis over the life of the direct loan or loan guarantee,  excluding administrative costs.when the present value of estimated payments by the government  exceeds the present value of estimated payments to the government  (collections). When credit programs have a positive subsidy cost, they  require appropriations. Conversely, negative subsidy programs are those  in which the present value of estimated collections is expected to exceed  the present value of estimated payments.

Credit programs have a positive subsidy  FCRA requires that agencies have budget authority to cover credit  subsidy costs before entering into credit transactions. For their annual  appropriation requests, agencies estimate credit subsidy costs by  cohort. To estimate their subsidy costs, credit agencies estimate the  future performance of direct loans and loan guarantees. Agency  management is responsible for accumulating relevant, sufficient, and  reliable data on which to base these estimates. To estimate future credit  performance, agencies generally have models that include assumptions  about defaults, prepayments, recoveries, and the timing of these events  and are based on the nature of their credit programs. In addition to  assumptions based on agencies’ programs, agencies also must  incorporate economic assumptions included in the President’s budget for  credit subsidy calculations. An agency’s credit subsidy costs can be  expressed as a rate. For example, if an agency commits to guarantee  loans totaling $1 million and has estimated that the present value of cash  outflows will exceed the present value of cash inflows by $15,000, the  estimated credit subsidy rate is 1.5 percent.

Under FCRA, agencies generally must produce annual updates of their  credit subsidy estimates—known as reestimates—of each cohort based  on information about the actual performance and estimated changes in  future credit performance. This requirement reflects the fact that  estimates of credit subsidy costs can change over time. Beyond changes  in estimation methodology, each additional year provides more historical  data on credit performance that may influence estimates of the amount  and timing of future cash flows. Economic assumptions also can change  from one year to the next, including assumptions on interest rates. When  reestimated credit subsidy costs exceed agencies’ original credit subsidy  cost estimates, the additional subsidy costs are not covered by new  appropriations but rather are funded from permanent, indefinite budget  authority.

In addition to estimating credit subsidy costs for budgetary purposes, Ex- Im calculates future credit losses for its annual audited financial  statements. Ex-Im’s financial statements are prepared according to  generally accepted accounting principles in the United States applicable  to federal agencies. These principles require Ex-Im to follow Federal  Accounting Standards Advisory Board (FASAB) guidance when  establishing loss allowances for direct loans and loss reserves for loan  guarantees or insurance transactions to cover future credit losses.

section_title: Ex-Im’s Business Grew Substantially in Recent Years Due to Market Conditions and Other Factors
paragraphs: Ex-Im business activities grew substantially in recent years. From 1990  through 2012, Ex-Im’s financial exposure grew by more than 250 percent  (or about 120 percent after adjusting for inflation), with most of the growth  occurring after 2008 (see fig. 1). From 1990 through 2007, Ex-Im’s  exposure grew from about $30 billion to $57.5 billion—an average annual  increase of just under 4 percent. From 2008 through 2012, Ex-Im’s  exposure rose from $58.5 billion to $106.6 billion—an average annual  growth rate of more than 16 percent.

Most of Ex-Im’s recent growth occurred through its long-term loan  guarantee and direct loan products. Overall, annual Ex-Im authorizations  rose from $14.4 billion in 2008 to $35.8 billion in 2012 (see fig. 2). Over  the same period, annual authorizations for long-term products grew from  $8.5 billion to $26.6 billion—a more than three-fold increase—and  accounted for almost 75 percent of the authorizations Ex-Im made in  2012. In particular, annual authorizations for new project and structured  finance transactions, almost all of which used long-term loan guarantees  and direct loans, increased from $1.9 billion in 2008 to $12.6 billion in  2012, or almost half of the long-term authorizations that Ex-Im made in  2012.

By region, annual authorizations grew most rapidly in Asia and Oceania  (see fig. 3). For example, Ex-Im authorizations for export financing to Asia  grew from $3.6 billion in 2008 to $13.5 billion in 2012, an increase of  about 275 percent. Overall, Asia accounted for almost 38 percent of Ex- Im’s authorizations in 2012. Financing for exports to Oceania, which  accounted for a smaller portion (about 9 percent) of Ex-Im’s 2012  authorizations, rose even more sharply—from about $1 million in 2008 to  $3.2 billion in 2012.

By industry sector, financing for aircraft industry exports was the single  largest source of authorizations in recent years, but authorizations in  other sectors grew more quickly (see fig. 4). Aircraft-related  authorizations grew from $5.7 billion in 2008 to $11.9 billion in 2012—an  increase of about 110 percent—and accounted for about one-third of Ex- Im’s authorizations in 2012. Over the same period, authorizations in the  service sector rose more than 20-fold—from $229 million to $5.3 billion— and represented 15 percent of Ex-Im’s authorizations in 2012.  Additionally, authorizations increased by more than 400 percent in the  power utilities sector (from $0.6 billion to $3.1 billion) and by more than  130 percent in the oil and gas mining sector (from $1.8 billion to $4.2  billion). The power utilities sector and oil and gas mining sector accounted  for 9 percent and 12 percent of Ex-Im’s 2012 authorizations, respectively.

Ex-Im officials and all of the representatives from industry trade  associations and research groups we interviewed agreed that reduced  availability of private-sector financing after the 2007-2009 financial crisis  was the leading factor contributing to increased demand for Ex-Im  financing. For example, officials from Ex-Im’s Policy and Planning Group  and industry representatives told us that the growing reluctance of  commercial banks to provide export financing in the wake of the financial  crisis was a primary driver of Ex-Im’s growth. They explained that the  financial crisis diminished the availability of commercial lending and that  Ex-Im provided financing to fill the void. Officials from the foreign ECAs  we contacted described similar effects on their business activity. For  example, officials from the ECAs in Canada and France explained that as  commercial banks withdrew from the trade finance market, their own  export credit activities grew as they made efforts to fill the resulting gap.

Officials from Ex-Im, industry trade and research organizations, and other  ECAs we interviewed, also said that the ongoing and future  implementation of international banking standards further limited private- sector financing, contributing to growth in ECA activities. For example,  officials cited the Basel Committee on Banking Supervision “Basel III”  standards for banking institutions that include risk-based capital and other  requirements. As of December 2012, U.S. regulators were preparing to  finalize rules for implementation of these standards. Ex-Im’s 2011 report  to Congress on export credit competition notes that the transition to Basel  III practices would require most banks to increase prices for export and  other types of financing, and consequently, direct loans from ECAs  became the preferred mechanism for some long-term trade deals.five representatives from industry trade associations and research groups  with whom we discussed this issue agreed that the ongoing  implementation of Basel regulations could further constrain private-sector  export financing in the already tightened lending environment following  the financial crisis. Similarly, officials from Canada’s ECA noted that their  business increased partly in response to banks’ plans for implementing  Basel requirements.

Commercial bank lending trends in the United States and Europe broadly  demonstrate the reduced availability of private-sector financing during the  2007-2009 financial crisis, including for U.S. small businesses. As shown  in figure 5—which shows the percentage of lenders that tightened or  eased credit standards at different points in time—credit standards  generally tightened during the financial crisis. Following the crisis, more  U.S. banks began to ease rather than tighten credit standards, while more  banks in the euro area continued to tighten standards, though not as  dramatically as they had during the crisis.

In emerging markets, following the onset of the 2007-2009 financial crisis,  perceptions of risk and the cost of credit in corporate bond markets also  jumped—dramatically for higher-risk borrowers. As shown in figure 6, risk  premiums for corporate bonds spiked in late 2008 and early 2009 and  remain above precrisis levels.

Ex-Im and officials from industry trade associations and foreign ECAs  noted the significance of Ex-Im’s direct loan product to Ex-Im’s recent  growth. For example, in its 2011 report to Congress on export credit  competition, Ex-Im noted the competitive advantage that direct loans—a  product not offered by some other ECAs—gave Ex-Im and other ECAs  with similar products. As previously shown in figure 2, long-term direct  loan authorizations grew from $356 million in 2008 to almost $12 billion in  2012. Representatives from industry trade associations noted that Ex- Im’s ability to offer direct loans helped Ex-Im to fill the gap in private- sector lending following the financial crisis and implementation of more  stringent banking regulations. Other ECAs also pointed to direct lending  as contributing to their ability to fill financing gaps following the recent  financial crisis. Of the four foreign ECAs we interviewed, two (Canada  and Japan) had existing direct lending capability prior to the 2007-2009  financial crisis. Both agreed that their capability to make direct loans was  an important factor in their ability to fill trade financing gaps.

Ex-Im officials and representatives from industry trade associations and  research groups identified other possible drivers of Ex-Im’s business that  may have contributed to the recent growth trend. These include increased  demand for U.S. goods and services from emerging markets, increased  production by significant Ex-Im customers, Ex-Im’s outreach efforts to  small businesses and key export markets, and Ex-Im’s response to  growing competition from foreign ECAs. First, Ex-Im has suggested that  demand for U.S. exports, particularly from industrializing emerging  markets (such as in Asia), adds to demand for Ex-Im services. For  example, as shown previously in figure 3, Ex-Im authorizations in Asia  grew more than 275 percent from 2008 through 2012. While Ex-Im  activity in some emerging markets did grow in recent years, we did not  find evidence of a positive correlation between Ex-Im activity and U.S.  exports. For example, Ex-Im’s highest growth came in 2009, when total  U.S. exports and U.S. exports to emerging markets were falling.

Second, Ex-Im officials also said that increased production by Boeing, Ex- Im’s primary aircraft exporter, contributed to authorization growth.  Officials emphasized that while Ex-Im’s significant activity in the airline  sector has contributed to Ex-Im’s recent growth, they did not expect  growth in the aircraft sector to continue at the same high rate, because  the commercial market for aircraft finance is beginning to recover and  implementation of a 2011 international agreement among OECD ECAs  may result in ECA financing being less competitive than commercial  financing.authorizations—the single largest industry Ex-Im supports.

Nonetheless, for 2012, aircraft represented 33 percent of new  Third, according to Ex-Im officials, Ex-Im’s efforts to offer small business  products and increase awareness of available export financing assistance  also may have been a factor in its recent growth. Ex-Im recently launched  several new small business products and opened four new regional  Export Finance Centers throughout the United States to support small  business exporters. These efforts stem from Ex-Im’s mandate to make available at least 20 percent of annual authorizations to small businesses.  Ex-Im officials explained that outreach efforts are important because  meeting the 20 percent small business requirement has been increasingly  difficult as Ex-Im’s overall portfolio has grown. In addition to its small  business outreach, Ex-Im has been identifying private-sector and public- sector buyers, financial institutions, and key governmental agencies for  each of nine foreign “key markets” where it expects U.S. export growth to  be strongest in the near future. In its 2010-2015 strategic plan, Ex-Im  cites these country outreach efforts as a way to focus limited Ex-Im  resources in areas with high potential for furthering the agency’s mission  of supporting exports and the jobs they provide. Ex-Im selected the key  markets based on a number of factors, including the size of the export  market for U.S. companies, projected economic growth, anticipated  infrastructure demand, and the need for Ex-Im financing. According to Ex- Im officials, some of these efforts already have produced new  transactions in markets such as Brazil.

Lastly, according to Ex-Im and representatives from industry trade  associations and research groups, Ex-Im’s activity may continue to grow  in response to increased competition from other ECAs, particularly those  in non-OECD countries, but none of the other ECAs we spoke with  suggested that this was a significant factor. Ex-Im’s 2012 Annual Report  emphasizes the importance of its role in ensuring that U.S. exporters  have a fair opportunity to compete with foreign exporters. While the  OECD Arrangement governs various aspects of U.S. and other member  ECAs’ activities, non-OECD ECAs sometimes offer financing terms more  favorable than the terms permitted under the OECD Arrangement. Ex-Im  can respond to foreign competition in export financing by notifying OECD  that it is meeting terms offered by other ECAs in order to preserve U.S.  exporters’ competitiveness. But, because these ECAs are not beholden to  the transparency requirements of the OECD Arrangement, it can be  difficult to confirm the terms and conditions of non-OECD ECA export  financing transactions. Some representatives from industry trade  associations and research groups we interviewed agreed that Ex-Im’s  response to competition from non-OECD ECAs, particularly China, may  have been, and likely would continue to be, a significant factor in  increased Ex-Im activity. Others, such as officials from the Berne Union (a  worldwide association for export credit and investment insurers) noted  that while competition based on financing terms might be a significant  determinant for a small number of international trade transactions,  importers primarily base purchase decisions on the equipment or services  that best meet their needs. None of the officials from the four foreign  ECAs we interviewed suggested that increased competition was a  significant factor in their own or Ex-Im’s activity growth.

section_title: Ex-Im Uses Modeling to Estimate Subsidy Costs and Reserves, and Accounts for Multiple Risks in These Processes and in Setting Fees
paragraphs: Ex-Im uses a loss estimation model to estimate credit subsidy costs and  loss reserves and allowances. This model accounts for various risks and  underwent a major update in 2012, but opportunities exist for additional  improvements. Ex-Im’s product fees account for credit and political risk  and are guided by international agreements and internal analyses.
subsections: section_title: Ex-Im Overhauled its Loss Model in 2012
paragraphs: Ex-Im uses a loss estimation model to build the agency’s credit subsidy  estimates in the President’s budget as well as for calculating loss  reserves and allowances reported in Ex-Im’s annual financial statements.  The model includes quantitative and qualitative factors to account for  various risks facing the agency. In 2012, Ex-Im made several adjustments  to the model to better account for uncertainty associated with a growing  portfolio and changing economic conditions. However, opportunities exist  for additional improvements.

The model considers historical data, as well as qualitative information, to  estimate loss rates on Ex-Im’s transactions—that is, the percentage loss  that Ex-Im can expect for each dollar of export financing. Mathematically,   Ex- the loss rate is the probability of default times the loss given default.Im’s current model uses historical information on loan guarantee and  insurance transactions authorized from 1994 through 2011.information includes the default and loss history of those transactions as  well as variables that are predictive of defaults and losses, including  transaction amount and length, obligor type, product type, and “risk  rating”—a numerical risk score that Ex-Im assigns to each transaction.  The model calculates a loss rate for each Ex-Im risk rating and product  type.

As previously noted, risk ratings are a key variable in the loss model. Ex- Im underwriters assign the ratings, which are based on assessments of  credit, political, and market risks. risky) to 11 (most risky). These risk ratings are determined partly through  the Interagency Country Risk Assessment System (ICRAS), a working  group that includes Ex-Im and other federal agencies involved in  providing international credit. According to Ex-Im, for each country,  ICRAS ratings are based on entities’ (1) ability to make payments as  indicated by relevant economic factors, and (2) willingness to pay as  indicated by payment record and political and social factors. There are  two types of ICRAS ratings—one for foreign government (sovereign)  borrowers and one for private-sector entities in foreign countries. For  transactions with foreign governments, Ex-Im officials apply the ICRAS  sovereign-risk rating. For transactions with private-sector entities, Ex-Im  officials assign risk ratings based on the ICRAS private-sector rating and  potentially other information such as obligor financial statements and  ratings of the obligors by credit rating agencies.

Ex-Im does not assign risk ratings to short-term insurance in multibuyer transactions or  to working capital transactions. All long- and medium-term transactions and short-term  insurance in single-buyer transactions are assigned risk ratings.

The loss rates produced by the model are used to estimate future cash  flows, which, in turn, are used to determine credit subsidy costs contained  in the President’s budget and to calculate loss reserves and allowances  reported in Ex-Im’s annual financial statements. To estimate the subsidy  costs of future transactions as part of the annual budget process, Ex-Im  uses the loss rates to help determine cash inflows (such as repayments,  fees, and recoveries) and outflows (such as claims) for the book of  business it expects in the upcoming year. Because the cash inflows and  outflows occur in the future, they must be discounted to determine their  net present values. To do this, OMB guidance requires Ex-Im to enter  cash flows into OMB’s credit subsidy calculator, which generates the  original credit subsidy cost estimate for that book of business. In  accordance with FCRA, the discount rates in the OMB credit subsidy  calculator are based on interest rates for U.S. Treasury securities.

Ex-Im also uses the estimated future cash flows to calculate loss reserves  or allowances—financial reporting accounts for estimated losses—for  each transaction at authorization. The total loss reserves and allowances  are reported in Ex-Im’s annual financial statements. Each year, Ex-Im  adjusts the loss reserve or allowance amount for each transaction using  updated estimates of future cash flows, which consider the impact of  actual credit performance and estimated changes in future credit  performance.

In addition to the risks discussed previously, the loss model also accounts  for the foreign-currency risk Ex-Im faces from its transactions  denominated in a foreign currency. In 2012, Ex-Im authorized about $1.7  billion in guarantees denominated in a foreign currency, or about 5  percent of its total authorizations for that year. According to an Ex-Im  official, the loss model uses a methodology that captures the cost of  buying a foreign currency at a particular time in the future. Therefore,  Ex-Im factors this cost into the credit subsidy cost and the related loss  reserve or allowance at the time it authorizes a transaction denominated  in a foreign currency and updates it during the reestimate process. In  addition, an Ex-Im official told us that Ex-Im adjusts its loss reserves  monthly to reflect changes in currency exchange rates.

Ex-Im adjusts the loss estimation model annually to enhance the reliability  of loss rates used to estimate subsidy costs and calculate loss reserves  and allowances. In 2012, Ex-Im made several adjustments to both  implement recommendations from external auditors and the Ex-Im IG and  to make the model more flexible for the various types of transactions in its  portfolio. Among other things, Ex-Im changed how it used its historical  dataset and added several qualitative factors.

Due to data limitations, Ex-Im’s model does not control for the age of  transactions in estimating the probability of default, potentially reducing   Ex-Im changed how it used the dataset  the precision of the estimates.underlying the loss model, which helped to mitigate this limitation.  Specifically, to help avoid underestimating the probability of default, Ex-Im  removed transactions authorized in 2012 from the dataset because these  transactions generally did not have enough time to default. Ex-Im also  excluded any long-term transactions that were within 3 years of the  obligor’s first payment. In addition, Ex-Im removed all transactions that  had not been disbursed as of June 30, 2012, because some transactions  are never disbursed and therefore never have the opportunity to default.  According to Ex-Im, these changes were made so the dataset more  accurately reflected the nature of its defaults. An Ex-Im report on the  2012 changes to the loss model stated that these adjustments increased  the percentage of defaulted transactions in the dataset—from 14 percent  to 19 percent for loan guarantee transactions and from 11 percent to 14  percent for insurance transactions. From a dollar perspective, the  adjustments increased the loss rate for transactions in the dataset from  0.9 percent to 1.2 percent for loan guarantees and from 6.2 percent to 6.9  percent for insurance transactions.

Consistent with audit recommendations and industry best practices, Ex- Im also incorporated five qualitative factors into the loss model in 2012 to  adjust for circumstances that may cause estimated losses to differ from  historical experience. Ex-Im added these factors in recognition of the  substantial growth in Ex-Im’s portfolio in recent years and of the potential  differences between its historical loss experience—on which the  quantitative part of the model is based—and future loss experience.  According to Ex-Im, the five qualitative factors enhance the reliability of  the model by better accounting for uncertainty in loss expectations. Four  of the five qualitative factors Ex-Im added to the model in 2012 increased  the estimated loss rate, and therefore increased the related loss reserve  and allowance amounts for some transactions.

The five qualitative factors are as follows:

Minimum loss rate. Ex-Im established minimum loss rates for products  that historically had very low losses and therefore would have very  low estimated loss rates based solely on historical data. According to  Ex-Im, they added this factor to recognize that although some  segments of the data may have low (or zero) historical loss rates Ex- Im should not forecast no losses in the future. The minimum loss rates  affected sovereign and other public-sector transactions of long terms  with good risk ratings and some short-term insurance transactions  with good risk ratings. Ex-Im’s 2012 report on the loss model stated  that the addition of this qualitative factor increased loss reserves and  allowances by 2 percent.

Global economic risk. This factor attempts to account for some market  risks associated with changes in international economic and business  conditions that may affect Ex-Im’s portfolio and make future losses  differ from historical losses. First, Ex-Im uses a 1-year forecast from  Moody’s of default rates on speculative-grade corporate bonds to  predict an Ex-Im default rate.Im’s historical default experience. If the estimated default rate is  greater than Ex-Im’s historical experience, Ex-Im increases its loss  estimate in proportion to the difference between the estimated default  rate and its historical experience. For 2012, this factor did not result in  an adjustment to Ex-Im’s loss model.

Ex-Im then compares this rate with Ex-

Portfolio concentration risk, including the three factors of region  concentration, industry concentration, and obligor concentration in the  aircraft portfolio. Ex-Im added these three qualitative factors to adjust  loss rates to account for uncertainties associated with growing  concentrations in its portfolio. Conceptually, the region and industry  concentration factors treat each growing region and industry as if it  were an entity that was issuing debt—making the entity more risky  and potentially lowering its credit rating. Ex-Im used certain credit  rating agency methodologies to develop synthetic ratings for each  “entity” and used these ratings to adjust loss rates for transactions in  the corresponding regions or industries. Ex-Im’s 2012 report on the  loss model stated that the addition of the region concentration factor  and the industry concentration factor increased loss reserves and  allowances by 7 percent and 13 percent, respectively. Ex-Im also  developed a concentration factor for obligors in the aircraft sector,  which accounted for 46 percent of Ex-Im’s exposure at the end of  2012. For example, this factor increases the loss rate for an aircraft  transaction if the estimated loss given default (based only on the  market value of the aircraft and the transaction amount) is larger than  the loss given default predicted by the model (which incorporates  other factors). Ex-Im indicated that the addition of the obligor  concentration factor increased loss reserves and allowances by 0.8  percent.

section_title: Opportunities Exist for Improvements to the Loss Estimation Model
paragraphs: Notwithstanding recent enhancements to the loss estimation model,  opportunities exist for additional improvements to the model, as well as  Ex-Im’s model development and validation processes. Ex-Im’s  independent financial statement auditor and Ex-Im’s IG have made recent  recommendations designed to improve Ex-Im’s loss modeling process. In  conjunction with its audit of Ex-Im’s 2012 financial statements, Ex-Im’s  independent financial statement auditor reviewed the loss model and  found it to be reasonable overall. However, the auditor recommended  additional improvements to Ex-Im’s loss modeling process, including (1)  considering enhancements to the adjustment for global economic risk by  using economic data or related indicators that would better predict the  overall impact to the portfolio; (2) conducting analysis to determine events  that trigger defaults; (3) identifying and monitoring industry-specific  drivers of risk; and (4) having an independent department or service  provider test the accuracy of the model. Ex-Im officials stated they would  take these recommendations into consideration as they update the model  for the next fiscal year. Additionally, in its September 2012 report, the Ex- Im IG recommended that Ex-Im design and implement a formal  governance framework that defines roles and responsibilities for financial  models and includes policies and procedures for validating models. Ex-Im  agreed with the recommendation and noted that it has begun developing  a formal governance framework for financial models. Also, Ex-Im said that  it will conduct external validations of future financial models.

As previously discussed, Ex-Im incorporated a qualitative factor into the  model to adjust the loss estimates to account for uncertainty related to  potential changes in global economic conditions. The factor uses a 1-year  forecast of bond defaults to make this adjustment. According to Ex-Im,  the bond default rates originally forecasted each year correlated with Ex- Im’s observed default rates between 1994 and 2011. In addition, Ex-Im  officials said the 1-year forecast was appropriate because Ex-Im will use  subsequent 1-year forecasts in annual updates to the loss model.  However, a 1-year forecast may not capture the uncertainty associated  with Ex-Im’s longer-term transactions, and the use of subsequent short- term forecasts does not address this limitation. FASAB guidance for  federal credit agencies states that agencies should develop cash flow  projections for their transactions based upon the best available data.

One-year forecasts may not represent the best available data for  transactions that span multiple years. As a result, Ex-Im may not be  making the appropriate adjustment to the estimated future losses, which  could lead to underestimation of loss rates, credit subsidy cost estimates,  and the related loss reserves and allowances for financial reporting  purposes.

section_title: Ex-Im’s Fees Are Guided by International Agreements and Internal Analyses
paragraphs: Ex-Im’s fees for medium- and long-term products account for the credit  and political risk associated with each transaction and are guided in large  part by the OECD Arrangement, which establishes guidelines for  determining “minimum premiums”—fees to cover the risk of not being  repaid—and minimum interest rates that participant ECAs charge. Ex- Im officials told us that the “exposure fee” they charge is generally the  minimum premium required by the OECD Arrangement, but that the  OECD Arrangement allows them to increase this fee if they deem that the  minimum premium does not cover the risk of a transaction. Ex-Im also  charges the minimum interest rate required by OECD, but can charge  above that rate.

Ex-Im’s pricing structure for medium- and long-term products (about 85  percent of Ex-Im’s exposure) includes the following:

Exposure fees. These fees cover the credit and political risks  associated with a direct loan, loan guarantee, or insurance  transaction. Ex-Im generally sets these fees at the level of the OECD  minimum premium.

Commitment fees. These fees are a flat percentage per year of the  undisbursed portion of a direct loan or loan guarantee that Ex-Im  charges to encourage the obligor’s use of the credit. These fees are  not meant to cover the risk of nonrepayment and are not guided by  the OECD Arrangement.

Interest rates on direct loans.minimum interest charge of 1 percentage point above the U.S.  Treasury rate for a security of comparable length.

The OECD Arrangement specifies a  To determine the OECD minimum premium for a direct loan, loan  guarantee, or insurance transaction, Ex-Im must take several aspects of  the transaction into account, including the following:

Obligor’s country. OECD established a system for classifying the risk  associated with transactions in different countries. OECD classifies  the countries using a scale from 0 (least risky) to 7 (most risky), and  Ex-Im applies the relevant country classification for each   These classifications take into account risks associated  transaction.with a country’s financial, economic, and political situation, as well as  the historical payment experience of ECAs that are members of  OECD and that have provided credit in the country.

Obligor’s credit risk. OECD established a framework for classifying  obligors based on credit risk and provides guidelines to assist  participant ECAs in doing so. Using the guidelines, Ex-Im places each  obligor into one of eight classifications, which range from better-than- sovereign credit quality (least risky) to weak credit quality (most risky).  Ex-Im uses the obligor’s recent financial information and other  information, such as the obligor’s industry position and ratings by  credit rating agencies, to assign a credit risk classification.

Other characteristics affecting the risk of nonrepayment. In  determining minimum premiums, Ex-Im also must take into account  the type of export financing product, the length of the transaction, and  the percentage of the overall credit amount for which Ex-Im is  responsible in the event of nonpayment. Additionally, the application  of risk-mitigation techniques, such as obligor credit enhancements,  reduces the minimum premium.

For specific types of medium- and long-term transactions, different  procedures apply. For example, for obligors in high-income OECD  countries, high-income euro area countries, or countries with an OECD  country risk classification of 0, the OECD Arrangement requires ECAs to  set fees based on available market information and the characteristics of  the underlying transaction. This is achieved by using prices of certain  comparable private-sector products, or “market benchmarks,” to help set  fees. The OECD Arrangement specifies seven products that participant  ECAs may use for this purpose, including certain corporate bonds and  certain credit default swaps. According to OECD, the level of country  risk is considered negligible for these countries, and the credit risk  associated with transactions in these countries is predominantly related to  the credit risk of the obligor. In addition, Ex-Im sets fees for its aircraft  transactions according to a separate OECD agreement, updated in 2011,   This agreement provides guidance on  specifically for the aircraft sector.the commitment fees to be charged in aircraft transactions. According to  Ex-Im, when the updated agreement is fully implemented in 2013, Ex-Im’s  fees for these transactions will rise substantially.

The fee structures for Ex-Im’s short-term products are not covered by the  OECD Arrangement or any other international agreements and differ by  export financing product, as follows:

Working capital. Ex-Im generally charges a fee of 1.75 percent of the  direct loan or loan guarantee amount. Ex-Im does not factor political  risk into its fees for this product because the obligors are U.S.  exporters. Ex-Im also generally does not differentiate between the  credit risk of different obligors.

Short-term insurance. Ex-Im’s fees include a premium that is based  on the length of the credit, the type of entity purchasing the export  (i.e., a foreign government, financial institution, or nonfinancial  institution), and the OECD country risk classification for the country of  the obligor. Some short-term insurance programs also factor into the  premium amount the credit risk of the obligor.

In 2011, Ex-Im conducted internal analyses to help ensure that the fees it  charges are sufficient to cover losses. For instance, Ex-Im officials told us  that in 2011 they determined that the credit subsidy rate for the working  capital program was positive by 9 basis points (0.09 percent), indicating  that fee levels for this program were not sufficient to cover losses. As a  result, in 2012 Ex-Im raised fees for the working capital program from 1.5  percent to 1.75 percent (or 25 basis points) of the direct loan or loan  guarantee amount to avoid the need for an appropriation to cover the  credit subsidy costs. Similarly, Ex-Im officials said the 2011 analysis  showed that one of Ex-Im’s short-term insurance products had a positive  subsidy cost. In response, Ex-Im implemented a more risk-based fee  structure to increase fees and make the product credit subsidy cost- neutral. Ex-Im officials said that they will conduct similar product analyses  on an annual basis. Whether recent fee changes will avoid the need for a  future credit subsidy will depend on the extent to which future losses are  consistent with Ex-Im’s historical experience.

section_title: Ex-Im Reported a Default Rate under 1 Percent and Generated Receipts, but the Long-Term Budgetary Impact Is Uncertain
paragraphs: Ex-Im calculates and reports default rates for its portfolio, but it has not  maintained data useful for assessing the performance of newer books of  business. Ex-Im has been self-sustaining for appropriations purposes  since 2008, but its long-term budgetary impacts are uncertain.
subsections: section_title: Ex-Im Has Not Maintained Data Useful for Assessing the Performance of Recent Business
paragraphs: As of December 31, 2012, Ex-Im reported a default rate for its active  portfolio of 0.34 percent. Ex-Im defines the active portfolio as those  transactions for which the maturity date has not been reached or that  have reached maturity but are still within the time frame during which a  claim can be submitted. Ex-Im calculates the default rate as the sum of  net claims paid on loan guarantees and insurance transactions and  unpaid past due installments on direct loans divided by disbursements.  Ex-Im’s default rate declined steadily from about 1.6 percent as of  September 30, 2006, to just under 0.3 percent as of September 30, 2012,  before edging up slightly by the end of the calendar year. However, this  downward trend should be viewed with caution because Ex-Im’s portfolio  contains a large volume of recent transactions that have not reached their  peak default periods. Recent transactions have had limited time to default  and may not default until they are more seasoned. For example,  according to Ex-Im, the peak default period for long-term loan  guarantees—which represent almost 57 percent of Ex-Im’s 2012  exposure—is about 3.9 years after authorization. As of the end of 2012,  about 53 percent of Ex-Im’s active long-term guarantees (in dollar terms)  had been authorized within the last 4 years. Therefore, the ultimate  impact of Ex-Im’s recent business on default rates is not yet known.

As of December 31, 2012, Ex-Im’s reported default rate varied by product  type, region, and industry. For example, default rates were 0.14 percent  for short-term products (working capital loan guarantees and insurance),  7.50 percent for medium-term products (direct loans, loan guarantees,  and insurance), and 0.20 percent for long-term products (direct loans and  loan guarantees). Among all products, the default rate ranged from a low  of 0.07 percent for working capital loan guarantees to a high of 8.74  percent for medium-term insurance. Across regions, default rates  ranged from 0.002 percent in Oceania to 0.58 percent in Asia. Across Ex- Im’s largest industry sectors, default rates ranged from 0 percent in oil  and gas to 0.71 percent in manufacturing.

A technique called vintage analysis is useful for examining the  performance of growing portfolios, but Ex-Im has not maintained the data  necessary to conduct such analysis. Vintage analysis separates and  compares the performance of seasoned cohorts and newer cohorts at  comparable points in time (for example, a certain number of years after  authorization). This technique can help evaluate the credit quality of  recent business by comparing the early performance of these cohorts  with the early performance of older cohorts. As such, it can provide early  warning of potential performance problems in newer business. Federal  banking regulator guidance suggests that banks conduct vintage analysis  to help manage growing portfolios. For example, the Federal Deposit  Insurance Corporation’s Risk Management Manual of Examination  Policies states that loan review and monitoring analysis should consider  the effects of portfolio growth and seasoning and that vintage analysis  can be used to do this. In addition, interagency guidance from federal  banking regulators states that reporting from management information  systems should include vintage analysis and that such analysis helps  management understand historical performance trends and their  implications for future default rates. Although Ex-Im information systems produce quarterly performance snapshots of individual cohorts, the  systems overwrite the snapshots with each quarterly update, according to  Ex-Im officials. Because Ex-Im has not retained historical cohort-level  performance data, it is unable to compare the performance of different  cohorts at comparable points in time. Ex-Im officials said that they use  several tools to provide early warning of performance problems, including  monitoring individual transactions of more than $1 million, maintaining an  Obligors of Concern List, and analyzing monthly and annual trends in  claims. However, by not maintaining the information necessary to  conduct vintage analysis, Ex-Im’s ability to understand the early  performance of recent cohorts and implications of this performance on  future default rates may be limited. Additionally, as previously noted, the  lack of point-in-time performance data may reduce the precision of Ex- Im’s loss estimation model.

Another measure of portfolio performance is the proportion of credit- impaired (impaired) assets to Ex-Im’s total exposure. Ex-Im defines  impaired assets as delinquent direct loans, loan guarantees, and claims  with an amount of $50,000 or more past due at least 90 days;  rescheduled direct loans, loan guarantees, and claims; or nondelinquent   A  direct loans, loan guarantees, and claims above a certain risk rating. substantial portion of Ex-Im’s impaired assets are from transactions that  preceded the implementation of credit reform in 1992. For example,  from 2008 through 2012, pre-credit reform transactions accounted for  about 50 to 60 percent of impaired assets each year. As a percentage of  total exposure, Ex-Im’s impaired assets generally declined over that  period (see fig. 7). In 2008, Ex-Im had about $3.4 billion in impaired  assets, which represented approximately 6 percent of total exposure at  that time. In 2010, the corresponding figures were about $4.4 billion and  5.8 percent. In 2012, impaired assets were approximately $2.6 billion, or  about 2.5 percent of Ex-Im’s total exposure for that year. Again, the trend  in this performance measure should be interpreted cautiously, because  Ex-Im’s portfolio was growing during this period, which resulted in more of  its portfolio being of recent vintage.

Ex-Im has been self-sustaining since 2008. Each year, Ex-Im is  appropriated a specified amount of funds for administrative costs and   However, since 2008, appropriation acts have  credit subsidy costs.required Ex-Im to repay appropriated funds dollar-for-dollar with offsetting  collections so that the result is a net-zero appropriation. Ex-Im’s offsetting  collections are generated by transactions that are initially estimated to  result in negative credit subsidies when fees collected from obligors are  estimated to be greater than estimated losses (net of recoveries). For  example, for 2012, Ex-Im was appropriated about $90 million for  administrative costs and $58 million for credit subsidy costs and also  authorized to retain up to $50 million in offsetting collections. That year,  Ex-Im generated about $1 billion in collections. With these funds, Ex-Im  reimbursed Treasury for the appropriation of administrative costs. In  addition, Ex-Im retained $108 million—the $58 million for credit subsidy  costs plus the $50 million in retained offsetting collections—for obligations  occurring within the next 3 years. Unlike the administrative costs  appropriation, which Ex-Im must repay in the same year as received, Ex- Im has 3 years to repay the credit subsidy appropriation and obligate the  $50 million it retained in offsetting collections. The remaining collections,  roughly $800 million, were sent to Treasury.

According to Ex-Im, since the implementation of FCRA, it has sent about  $5.8 billion more to Treasury than it has received in appropriations. From 1992 through 2012, Ex-Im was appropriated about $9.8 billion for  credit subsidy costs and administrative costs. Over the same period, Ex- Im sent about $15.6 billion to Treasury as a result of credit subsidy  reestimates ($12 billion), cancelled authority ($1.6 billion), returned  collections ($1.3 billion), and rescissions ($675 million).billion of the $5.8 billion net return to Treasury occurred from 2008  through 2012.

We determined that Ex-Im’s figures for appropriations received and amounts sent to  Treasury were reasonable based on our analysis of Ex-Im appropriations acts, budget  appendixes, and financial statements from 1992 through 2012. downward reestimates in the early- to mid-2000s were due primarily to a  switch from standard loss rates prescribed by OMB to loss rates that  reflected Ex-Im’s historical experience, which tended to be lower. Ex-Im  officials attributed the upward reestimates in 2010 to changes they made  that year in their loss estimation model to account for increased loss  experience in 2009 and uncertainty stemming from the global financial  crisis. Ex-Im officials said that the upward reestimates for 2011 and 2012  for direct loans stemmed from declines in obligor interest rates, which  reduce estimated cash flows. In addition, Ex-Im officials said they  expected further upward reestimates due to modeling changes they made  in 2012, including the addition of the qualitative factors discussed  previously. These modeling changes will be reflected in the subsidy  estimates and reestimates in the 2014 budget.

The extent to which Ex-Im will continue to send more funds to Treasury  than it receives in appropriations and permanent, indefinite budget  authority will depend partly on future credit subsidy reestimates. Credit  subsidy estimates are based, in part, on economic assumptions that are  uncertain and can change from year to year. In addition, the estimates  are developed using Ex-Im’s loss estimation model, which is not intended  to capture the impact of unexpected economic scenarios that could  substantially affect Ex-Im’s losses. Therefore, changes in underlying  assumptions or adverse economic events could result in upward subsidy  reestimates that may require drawing on permanent and indefinite budget  authority.

section_title: Ex-Im Faces Operational Risks from Its Growing Portfolio
subsections: section_title: Ex-Im Uses Various Techniques to Manage Transaction Risks
paragraphs: Ex-Im uses a number of risk-management techniques throughout the  different stages of a transaction, which include underwriting, monitoring  and restructuring, and claims and recovery. In January 2013, Ex-Im  completed a comprehensive revision of its policies and procedures  manual that covers each stage.

Ex-Im manages risks through the underwriting process in several ways.  First, Ex-Im produces a Country Limitation Schedule (CLS) that specifies  the types of transactions eligible for financing in each country and the  conditions under which they are eligible. For example, in some countries,  Ex-Im will not provide financing because the credit and political risks are  deemed to be too high or because of legal prohibitions. In countries  where Ex-Im does business, Ex-Im may only provide financing for  transactions of certain durations or for either public- or private-sector  borrowers. Ex-Im has basic eligibility requirements for obligors. For  example, an obligor must not have been suspended or debarred from  doing business with the U.S. government and may be required to have  been in the same line of business for a specified number of years.  Requirements for obligors also vary by product type and transaction  length.

For transactions that meet CLS and eligibility requirements, Ex-Im  assigns a risk rating used to determine whether there is a reasonable  assurance of repayment. As previously discussed, the ratings range from  1 (least risky) to 11 (most risky). For transactions conveying the full faith  and credit of a foreign government, Ex-Im officials apply the ICRAS  sovereign risk rating. ICRAS ratings for sovereign obligors are based on  macroeconomic indicators, such as indebtedness levels, balance-of-  payments factors, and political and social factors. For most private-sector  transactions, Ex-Im officials use the private-sector ICRAS rating as a  baseline and adjust that rating depending on their assessment of the  obligor’s creditworthiness and other factors. ICRAS ratings for private- sector transactions in a country are based on qualitative and quantitative  assessments of the depth of private-sector business activity in a country,  the strength of private-sector institutions, foreign exchange availability,  political stability, and other factors. Ex-Im officials assess obligors’  creditworthiness by reviewing information including financial statements  and corporate credit ratings. For more complex transactions, Ex-Im  considers additional information to develop the risk rating. For example,  for project finance transactions, Ex-Im considers the allocation of risk  among project participants, the financial strength of the project, and  market pricing of project inputs and outputs. Ex-Im generally does not  authorize transactions with risk ratings over 8.

In addition to the CLS and risk rating, Ex-Im uses other processes,  standards, and conditions in underwriting transactions. Examples of these  include the following:

Due diligence process. Ex-Im reviews information related to the  integrity of the transaction and the character and reputation of the  participants. For example, Ex-Im determines whether it has had  adverse prior experience with a participant or if the participant  presents a risk due to poor references or investigations by local legal  or regulatory authorities.

Collateral standards. As applicable, Ex-Im requires assets to secure  the transactions and prefers the asset value to exceed the loan value  in most transactions. For example, working capital loan guarantees  must be secured by raw materials, finished goods, accounts  receivable, or other specified assets. Additionally, each Ex-Im aircraft  transaction is secured not only by the aircraft being financed under  that transaction, but also by any other aircraft Ex-Im is currently  financing for the obligor.

Risk-sharing conditions. These conditions require lenders and  exporters to share a percentage of the credit risk with Ex-Im. For  example, for working capital loan guarantees, Ex-Im guarantees 90  percent of the principal and interest on a loan issued by a private  lender. In the event of a claim, Ex-Im reimburses the lender for 90  percent of both the outstanding principal balance of the loan and  accrued interest, and the lender is responsible for the remaining 10  percent.

Ex-Im monitors the performance of all medium-term direct loan, loan  guarantee, and insurance transactions and long-term direct loan and loan  guarantee transactions above $1 million to help contain risk. Ex-Im  conducts ongoing reviews of these transactions to identify and address  any deterioration in credit quality before the obligor defaults. This includes  assessment of the operating environment and financial condition of the  obligor to determine whether or not there have been changes that might  increase or decrease credit risk. Ex-Im updates a transaction’s risk rating  at least annually to reflect any changes in credit risk, which, in turn,  affects the estimated credit subsidy cost and loss reserve or allowance  associated with the transaction. Specific monitoring activities include  evaluating the capacity of obligors to repay their debts, reviewing the  value of pledged collateral, and staying abreast of actions by the obligor  to respond to adverse market changes, and on-site visits at crucial project  milestones (as applicable). Through the monitoring process, Ex-Im  develops a Watch List, which tracks transactions that show signs of  impairment, and an Obligors of Concern List, which tracks transactions  that are impaired. These transactions are subject to more frequent  monitoring than other transactions. In addition, monitoring staff share  these lists with the Office of the Chief Financial Officer and other senior  management to keep them informed of emerging credit issues.

According to Ex-Im, no lenders failed the 156 examinations conducted from 2008  through 2012.

Im. Further, in 2012, Congress directed Ex-Im to improve and clarify its  due diligence procedures.expected to have the revised procedures completed by the summer of  2013.

In response, Ex-Im officials said they  Ex-Im restructures transactions with credit weaknesses to help prevent  defaults and increase recoveries on transactions that do default.  According to Ex-Im, restructuring can involve substantial revision of  transaction terms and conditions. For example, in 2012, Ex-Im  restructured a defaulted project finance transaction into a direct loan with  the implicit backing of a foreign government. Restructuring can also  involve the addition of credit enhancements such as extra collateral or  third-party guarantees. According to Ex-Im, the agency restructures as  many as eight transactions per year. According to Ex-Im officials, the  agency is developing a dedicated restructuring team to help reduce the  workload of staff currently responsible for both monitoring and  restructuring tasks. In addition, they indicated that restructuring staff  inform underwriting staff of trends in credit deteriorations or problems with  particular borrowers to help ensure that any lessons learned are applied  to future transactions.

Ex-Im pays claims when a loan that it has guaranteed or an insurance  policy that it has issued defaults. Ex-Im tries to minimize losses on  claims paid by pursuing recoveries. For example, Ex-Im takes steps to  collect on the assets of the obligors, which can include the collateral  backing a transaction. For all products combined, Ex-Im’s recovery rate— the total amount recovered divided by the total amount of claims paid plus  recovery expenses—was about 50 percent on average from 1994 through  2012. In addition, when Ex-Im pays a claim for a loan guarantee that is  denominated in a foreign currency, Ex-Im manages its foreign-currency  risk by purchasing the foreign currency to pay the claim to the lender and  then seeks recovery on the U.S. dollar equivalent, which represents the  obligor’s debt obligation. This policy effectively shifts the foreign-currency  risk from Ex-Im to the obligor after a claim has been paid.

section_title: Ex-Im Has Started Developing a More Comprehensive Risk- Management Framework
paragraphs: In September 2012, the Ex-Im IG issued a report on Ex-Im’s management  of risk at the overall portfolio level. On the basis of industry best  practices, the report made a number of recommendations to improve Ex- Im’s portfolio management in areas such as stress testing, portfolio  concentrations, and risk governance. Our review of federal internal  control standards and industry practices suggests that the IG’s  recommendations in these areas represent prudent risk-management  techniques. Ex-Im has begun to implement some of the IG’s  recommendations and is in the process of analyzing others to determine  their applicability to Ex-Im and the risk-management benefits that could  be gained from them.

The Ex-Im IG recommended that Ex-Im develop a systematic approach to  stress testing its portfolio that would be conducted at least annually as  part of the process for reestimating credit subsidies. A stress test is a  “what-if” scenario that is not a prediction or expected outcome of the  economy. Stress testing is one tool to measure the vulnerability of  portfolios to unexpected losses—that is, losses associated with extreme  yet plausible events. The IG stated that in light of concentrations in Ex- Im’s portfolio, stress testing would provide Ex-Im information on how its  portfolio would react to shocks in financial markets. Ex-Im agreed to  implement this recommendation.

Stress testing is consistent with our internal control standards and  industry practices. For example, our internal control standards state that  agencies should have adequate mechanisms to identify risks arising from  external factors and analyze the possible effects of these risks.addition, in its best practices manual on credit portfolio management, the   In  International Association of Credit Portfolio Managers (IACPM) states that  institutions should conduct stress testing to inform management about the  portfolio’s vulnerabilities and to establish the portfolio’s sensitivity to risk  factors. Similarly, guidance from regulators of federal financial  institutions notes that the recent financial crisis underscored the need for  banking organizations to incorporate stress testing into their risk- management practices.credit agencies with which we spoke conduct stress testing on their  portfolios. For example, officials from one ECA told us that they conduct  stress tests every 6 months using scenarios related to current world  issues to determine the impact those scenarios would have on obligors.

Furthermore, the foreign ECAs and U.S. federal  Ex-Im officials stated that they have conducted ad hoc stress tests in the  past, but have been developing a systematic approach. This approach  will involve assessment of (1) how the entire portfolio or portions of the  portfolio would be affected by extreme economic events and (2) the  impact that particular adverse scenarios may have on specific obligors.  Ex-Im officials told us that they will first stress test the aircraft portfolio,  which accounts for about 50 percent of the agency’s exposure. According  to Ex-Im, the stress test results will be included in a quarterly internal  report on the financial status of Ex-Im’s portfolio. Ex-Im officials stated  that the results of the stress testing will be used to inform the loss  modeling process and will be used by senior management in making  decisions about the agency’s resource allocations and strategic planning  efforts. Ex-Im officials also indicated that they intend to share their stress  testing and loss modeling methodologies with other federal credit  agencies so that others may benefit from Ex-Im’s efforts.

Ex-Im has not yet made plans to report its stress scenarios and stress  test results to Congress. Such reporting could help Congress oversee Ex- Im’s activities by providing additional information on Ex-Im’s risk  exposure. Through provisions in the Export-Import Bank Reauthorization  Act of 2012, Congress has required Ex-Im to provide analysis of the  agency’s default rates and risk of loss associated with its increased  exposure limits. Information on Ex-Im’s stress testing would  complement that analysis by disclosing the magnitude of losses that Ex- Im could face under adverse scenarios. Additionally, reporting such  information would be consistent with our internal control standards, which  indicate that communications with external parties, including Congress,  should provide information that helps them better understand the risks  facing the agency.

As previously discussed, Ex-Im’s portfolio is concentrated in certain  industries, regions, and obligors. These concentrations expose Ex-Im to  the risk associated with negative events in those market segments. In  light of these concentrations, the Ex-Im IG recommended that Ex-Im  implement “soft portfolio concentration sublimits”—that is, informal  thresholds for the portion of total exposure within different segments of  the portfolio. The IG recommended that Ex-Im set the soft portfolio  sublimits by industry, geography, or transaction risk rating and use them  as internal guidance to inform future pricing and portfolio risk- management decisions (e.g., ways to diversify the portfolio). According to  IG officials, the establishment of soft portfolio sublimits (as opposed to  hard limits) would help Ex-Im manage portfolio concentrations without  restricting its ability to meet exporters’ demand for financing or adversely  affecting Ex-Im’s competitiveness with other ECAs.

Portfolio sublimits represent one technique for managing a “risk  appetite”—that is, the amount of risk an institution is willing to accept.  Setting a risk appetite is consistent with our internal control standards,  which state that agencies should develop an approach for risk  management based on how much risk can be prudently accepted.  Additionally, industry best practices identified by the Committee of  Sponsoring Organizations of the Treadway Commission (COSO), the  Institute of International Finance (IIF), and IACPM cite the establishment  of risk appetite, including through portfolio sublimits, as a sound risk- management practice.including the Overseas Private Investment Corporation (OPIC) and two  foreign ECAs, set a risk appetite by establishing limits on the volume of  financing they provide to different industries, countries, or obligors.  Setting a risk appetite can help senior management determine the point  at which the institution’s exposure has reached a level that may require  implementation of additional risk controls.

Some organizations with which we spoke,  As of December 2012, Ex-Im had not established soft portfolio sublimits.  However, Ex-Im officials said that they were evaluating whether this  practice was suitable for the agency in light of potential implications for  Ex-Im’s ability to meet client demands and competitiveness with other  ECAs. Given the potential benefits of this risk-management practice,  following through on this evaluation will be important for Ex-Im.  Furthermore, if it determines that soft portfolio sublimits are appropriate,  following industry guidance for setting a risk appetite will also be  important. For example, guidance issued by COSO in January 2012  states that in developing a risk appetite an institution should consider its  existing risk profile (current level and distribution of risks); risk capacity  (the amount of risk that an organization is able to support); risk tolerance  (the acceptable level of variation an organization is willing to accept); and  stakeholders’ attitudes towards growth, risk, and return.

In its September 2012 report, the Ex-Im IG also stated that Ex-Im’s risk  governance structure was not commensurate with the size, scope, and  strategic ambitions of the institution. Among other things, the IG noted that Ex-Im lacked an official responsible for managing the full spectrum of  risks facing the agency and developing risk-management strategies. The  IG recommended that Ex-Im create the position of chief risk officer (CRO)  to oversee the design and implementation of an enterprisewide risk- management function.

Industry best practices and corporate governance principles of the Basel  Committee on Banking Supervision highlight the importance of having  focal points for all the activities required to manage enterprisewide risks.  For example, best practices published by IIF state that financial firms  should assign responsibility for risk management to an officer at a senior  level, in most cases a CRO. The Global Association of Risk Professionals  has indicated that the typical roles of a CRO include establishing risk- management policies and procedures consistent with entitywide policies,  reviewing and approving models used for pricing and risk measurement,  measuring risk on a global basis as well as monitoring exposures and  changes in risks, and communicating risk-management results to senior  management. OPIC and some foreign ECAs with which we spoke have  CROs and cited benefits of this function, including risk assessment that is  independent from other business functions. For example, OPIC officials  said that OPIC’s CRO function is carried out by a small unit led by a  Director of Risk Management that reports directly to the agency’s Chief  Financial Officer.

Ex-Im does not have a centralized CRO function and instead distributes  responsibilities for risk management to several parts of the organization,  including the Office of the Chief Financial Officer, Office of General  Counsel, Credit Management Group, and Credit Policy Committee. For  example, the Office of the Chief Financial Officer’s responsibilities include  loss modeling, determining credit subsidy estimates, and portfolio  monitoring. The Office of General Counsel’s responsibilities include  conducting due diligence on transaction participants to manage  reputational risk and assisting in documenting transactions. The Credit  Management Group takes the lead in reviewing and recommending broad  credit policy and underwriting standards. Finally, the Credit Policy  Committee is responsible for formulating, coordinating, and making  recommendations to Ex-Im’s Board of Directors in the areas of country  risk, sovereign and private-sector risk, changing or modifying CLS, and  addressing other risk issues.

As of February 2013, Ex-Im officials told us that they were analyzing the  possibility of establishing a more centralized CRO function. The officials  said that in performing this analysis, they were reviewing other  organizations that have a CRO, including OPIC, the World Bank, the  International Finance Corporation, and the African Development Bank.  Careful consideration of the potential benefits of a CRO function and the  extent to which the agency’s current structure comprehensively  addresses enterprisewide risks is critical given Ex-Im’s growing financial  exposure. Further, taking into account the potential expansion of its risk- management activities, such as the implementation of soft sublimits and  regular stress testing, will be important for Ex-Im’s analysis.

In addition to the three recommendations discussed previously, the IG  recommended that Ex-Im: (1) develop a systematic approach for  modeling portfolio risk, including identifying appropriate qualitative risk  factors; (2) with the assistance of external experts, implement a formal  framework for the use of financial models, including procedures for model  validation; (3) review risk metrics and reporting procedures to enhance  transparency and to better inform key stakeholders; and (4) amend its by- laws to provide for oversight of an agencywide risk-management function  by Ex-Im’s Board of Directors. Ex-Im has taken actions to address the  first three of these recommendations. As already noted, Ex-Im  incorporated qualitative risk factors into its loss estimation model. In  addition, Ex-Im hired a contractor to serve as an external expert in  reviewing and analyzing Ex-Im’s loss estimation model and plans to  conduct external validation of future financial models. Ex-Im also began  issuing a quarterly default report and is identifying portfolio management  best practices—including risk metrics and reporting procedures—through  a review conducted by subject-matter experts. Ex-Im disagreed with the  fourth recommendation. Ex-Im stated that the agency’s charter does not  provide this oversight function to the Board of Directors, but rather  provides the President of Ex-Im broad operational authority for the  management of Ex-Im, including oversight of all of Ex-Im’s risk- management functions.

section_title: Ex-Im Has Not Yet Determined the Volume It Can Prudently Manage
paragraphs: Ex-Im’s annual authorizations increased from about $12 billion in 2006 to  nearly $36 billion in 2012, an increase of about 195 percent. Over the  same period, Ex-Im’s staff level, as measured by full-time equivalents  (FTE), increased from 380 to 390 FTEs, about 3 percent (see fig. 9).

The rapid increase in business volume, coupled with a modest growth in  FTEs, creates potential operational risks for Ex-Im. If demand for Ex-Im’s  services exceeded its capacity, the agency’s ability to properly underwrite  and monitor transactions might suffer. Agencywide, the average dollar  amount of annual authorizations per FTE rose from $32 million in 2006 to  about $92 million in 2012, an increase of more than 150 percent. Over the  same period, the number of transactions per FTE rose from 7.0 to 9.7, an  increase of 38 percent. Ex-Im acknowledged that its current resources  would not be sufficient for the high levels of activity it expected to see in  the coming years. In addition, Ex-Im division managers with whom we  spoke noted the strain of the increased and increasing workloads on  employees and said they could use additional staff. Ex-Im officials stated  that risks to the agency have been increasing as a result. While the  officials told us that the increased business volume primarily had affected  the underwriting function, the impact had been mitigated somewhat by the  agency’s delegation of some underwriting to private lenders for working  capital loan guarantees. However, the officials said that Ex-Im’s other  transaction-related functions, including legal and monitoring activities,  were expected to have significantly higher workloads as transactions  complete the underwriting phase and move on to other phases.

Ex-Im has taken some steps to manage its increased workload. Ex-Im  asked for additional administrative resources in its annual budget  requests, in part to hire more staff. For example, in its 2013 budget  request, Ex-Im requested a $7 million increase in administrative  resources to support underwriting and small business outreach. While  acknowledging the constrained federal budget environment, Ex-Im  officials said that future budget requests likely also would request  resources for additional staff. In the interim, Ex-Im officials said that when  vacancies occurred, they allocated the positions to areas of highest need  rather than automatically refilling the vacancies. Ex-Im also hired a  consultant to identify best practices for improving operational efficiency of  the monitoring function. In addition, Ex-Im officials said they planned to  update the agency’s 2009-2012 Human Capital Plan following a  forthcoming revision to Ex-Im’s strategic plan. Ex-Im’s workforce planning  process involves assessing its current workforce, anticipating future  needs, analyzing gaps, and developing strategies to address those gaps.

Although Ex-Im has acknowledged growing risks associated with its  increasing workload, it has not formally determined the level of business it  can prudently manage—either agencywide or within specific functional  areas—with a given level of resources. For example, while Ex-Im has  reported the average number and dollar amount of authorizations per  FTE, officials stated that they have not determined the level at which  operational risks are too high. Additionally, Ex-Im officials within different  functional areas were unable to provide formal, documented assessments  of resource needs. As previously noted, our internal control standards  state that agencies should develop an approach for risk management  based on how much risk can be prudently accepted. In addition, these  standards indicate that agencies should decide upon specific control  activities to manage or mitigate risks entitywide and at each activity level.  Ex-Im officials said the dramatic increase in business was not anticipated  and that the agency historically did not need to make major workforce  adjustments because its business volume was stable. However, without  benchmarks to determine when workload levels have created too much  risk, Ex-Im’s ability to monitor and manage operational risks associated  with its already increased business volume may be limited. Monitoring  workloads against such benchmarks would help Ex-Im determine when  additional steps—such as tightening underwriting standards or increasing  requirements for lender participation—may be needed to mitigate Ex-Im’s  increased risk. Moreover, legislated increases in Ex-Im’s exposure limits  provide room for additional increases in Ex-Im’s business volume, and  thus Ex-Im could continue to experience strains on its workforce.

section_title: Conclusions
paragraphs: In recent years, Ex-Im has assumed an increased role in supporting the  export of U.S. goods and services. In part, this increase resulted from a  decline in the availability of private-sector credit that accompanied the  2007-2009 financial crisis. For several years, Ex-Im has been self- sustaining for budgetary purposes, although the long-term cost of Ex-Im’s  new business is not yet known. In addition, Ex-Im has made recent  improvements to its risk management, including enhancements to its loss  estimation model and plans for a more systematic approach for stress  testing its portfolio. However, the growth in Ex-Im’s portfolio and the  spectrum of risks Ex-Im faces underscore the need for continued  improvements in risk management. Recommendations made by the Ex- Im IG in September 2012 and further supported by our work point to  additional steps that Ex-Im could take to strengthen its risk-management  framework. These steps include establishing soft portfolio sublimits and  assessing the benefits of a more centralized CRO function. Following  through on these recommendations will be critical to help manage the  risks and challenges associated with the agency’s greater financial  exposure.

In addition, our work identified other opportunities for Ex-Im to improve  how it monitors, manages, and reports on the risks it faces. First, while  Ex-Im added qualitative factors to its loss model in 2012, the factor that  adjusts loss estimates for potential changes in global economic conditions  uses a 1-year forecast for speculative-grade corporate bond defaults for  all its transactions, regardless of their length. Because many of Ex-Im’s  transactions span multiple years, a 1-year default forecast may not  represent the best available data for making default adjustments for these  transactions. The use of default forecasts or other economic data with a  longer time horizon may produce more reliable loss estimates and would  be consistent with FASAB guidance on using the best available data for  developing cash flow projections. Second, Ex-Im has not maintained the  data necessary to conduct vintage analysis, a technique federal banking  regulators have cited as useful for monitoring growing portfolios. Once a  sufficient amount of data has been retained, such an analysis could help  Ex-Im to assess the early performance of new books of business by  providing comparisons to seasoned books at a comparable point in time.  It could also provide Ex-Im an additional early warning indicator to assist  Ex-Im in taking timely actions to mitigate emerging risks. Such data also  have the potential to strengthen Ex-Im’s future loss modeling efforts by  providing additional information about when defaults occur over the life of  a transaction. Third, Ex-Im has made progress toward implementing a  systematic approach to stress testing its portfolio, but has not yet made  plans to report the scenarios and results to Congress. Providing this  information to Congress—potentially as part of Ex-Im’s annual report— would be consistent with federal internal control standards for effective  external communication and would aid congressional oversight of the  agency. Finally, although Ex-Im has recognized and taken some steps to  address workload challenges, it has not developed benchmarks for the  level of business it can properly support with a given level of resources.  This is contrary to federal internal control standards, which indicate that  agencies should develop a risk-management approach based on how  much risk can be prudently accepted. Ex-Im’s workload challenges may  continue to grow because of increases in Ex-Im’s exposure and exposure  limit, coupled with resource constraints in the current budgetary  environment. In the absence of workload benchmarks, Ex-Im lacks a  sound basis for workforce planning and for determining when additional  control activities might be needed to manage operational risks.

section_title: Recommendations for Executive Action
paragraphs: We recommend that the Chairman of the Export-Import Bank of the  United States take the following four actions:

To help improve the reliability of its loss estimation model, Ex-Im  should assess whether it is using the best available data for adjusting  loss estimates for longer-term transactions to account for global  economic risk.

To conduct future analysis comparing the performance of newer and  older business and to make future enhancements to its loss  estimation model, Ex-Im should retain point-in-time, historical data on  credit performance.

To help Congress better understand the financial risks associated with  Ex-Im’s portfolio, Ex-Im should report its stress test scenarios and  results to Congress when such information becomes available.

To help manage operational risks stemming from Ex-Im’s increased  business volume, Ex-Im should develop workload benchmarks at the  agencywide and functional area levels, monitor workload against  these benchmarks, and develop control activities for mitigating risks  when workloads approach or exceed these benchmarks.

section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to Ex-Im for its review and comment. In  written comments, which are reproduced in appendix II, Ex-Im agreed  with our recommendations. Ex-Im also provided technical comments that  we incorporated into the final report, as appropriate.

In its written comments, Ex-Im said it would begin to implement all four of  our recommendations in fiscal year 2013. Specifically, Ex-Im said it would  implement our recommendation to assess data for adjusting loss  estimates for longer-term transactions as part of a spring 2013  reevaluation of its loss estimation model. Concerning our  recommendation that Ex-Im retain point-in-time data on credit  performance, Ex-Im said it had already begun doing so and would use  these data to compare the performance of newer and older books of  business and to enhance its loss estimation model. Ex-Im also agreed  with our recommendation that it provide stress testing scenarios and  results to Congress and said it would include the results of its stress tests  in the default reports it submits to Congress. Ex-Im did not indicate  whether it would also include its stress test scenarios in the default  reports. Because stress testing results are only meaningful in the context  of the stress scenarios used, our recommendation emphasizes reporting  both types of information to Congress. Finally, concerning our  recommendation that Ex-Im set workload benchmarks to help manage  operational risk, Ex-Im said it planned to form an Enterprise Risk  Committee consisting of senior management from the business, financial,  legal, policy, resource, and risk-management areas. Ex-Im stated that  operational risk would be one of the first areas the committee examines.

We are sending copies of this report to appropriate congressional  committees and the Chairman of the U.S. Export-Import Bank. The report  is also available at no charge on the GAO website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-8678 or sciremj@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. GAO staff who made major contributions to this report  are listed in appendix III.

section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our objectives were to examine: (1) how the U.S. Export-Import Bank’s  (Ex-Im) business changed in recent years and possible reasons for these  changes; (2) how Ex-Im determines credit subsidy costs, loss reserves  and allowances, and product fees, and how these processes account for  different risks; (3) how Ex-Im’s financial portfolio has performed and the  budgetary impact of its programs; and (4) the extent to which Ex-Im has a  comprehensive risk-management framework.

To assess how Ex-Im’s business changed in recent years and possible  reasons for these changes, we analyzed information on Ex-Im’s financial  exposure and authorizations, including data from Ex-Im annual reports  and data compiled by the agency from its Ex-Im Bank Reporting System.  We examined Ex-Im’s total exposure levels for each year from 1990  through 2012 to identify growth trends both in nominal and inflation- adjusted terms. We also examined Ex-Im’s annual authorizations for each  year from 2006 through 2012. We chose that period in order to cover Ex- Im’s pre- and post-financial crisis business activity. We analyzed trends in  the dollar volume of Ex-Im’s total authorizations each year, the volume of  total U.S. exports, as well as Ex-Im authorization levels disaggregated by  product type, region, and industry sector. To identify possible reasons for  trends in Ex-Im’s business activity, we reviewed a variety of Ex-Im  documents, including annual reports, competitiveness reports, the  agency’s strategic plan for 2010-2015, and reports issued by Ex-Im’s  Office of Inspector General (IG). We also reviewed relevant reports by the  Basel Committee on Banking Supervision, academics, and foreign export  credit agencies (ECA). Because Ex-Im can play a countercyclical role in  export finance (i.e., expanding when private sector credit is retrenching),  we also analyzed data related to the availability and cost of credit from  2006 through 2012. In particular, we analyzed (1) calendar 2006-2012  survey data from the Board of Governors of the Federal Reserve System  and the European Central Bank on the percentage of commercial lenders  that were tightening or easing lending standards and (2) calendar 2006- 2012 data on corporate bond risk premiums from Bank of America-Merrill  Lynch. We also analyzed International Monetary Fund data on the volume  of U.S. exports over fiscal years 1990 through 2012 in order to compare  changes in export volume with changes in Ex-Im authorizations.  Additionally, we interviewed Ex-Im officials and six representatives of  industry trade associations and research organizations about reasons for  changes in the agency’s business volume. We selected the trade  association and research organization representatives to interview on the  basis of a literature review of relevant published articles, prior GAO work  on Ex-Im and international trade issues, and recommendations from  knowledgeable federal agency and industry officials about individuals with  expertise on Ex-Im’s activities or export financing generally. Our literature  review focused on publications that cited Ex-Im, export credit agencies,  trade finance, and export finance. Three of the entities we interviewed  represented industry trade associations (the Coalition for Employment  through Exports, the Berne Union, and the Bankers’ Association for  Finance and Trade and International Financial Services Association) and  three represented research groups (Peterson Institute for International  Economics, the Rhodium Group, and the Research Division of the U.S.  International Trade Commission). Further, to obtain perspectives on ECA  growth generally, we conducted telephone interviews with officials from  four foreign ECAs: Export Development Canada (Canada), Compagnie  Française d’Assurance pour le Commerce Extérieur (France), UK Export  Finance (United Kingdom), and Japanese Bank for International  Cooperation (Japan). We selected theses ECAs based on their similarity  to Ex-Im in terms of: (1) their role in supplementing rather than competing  with private markets for export credit support, (2) the types of export  credit products they offer, and (3) the presence of a small business  directive or mandate.

To examine how Ex-Im determines subsidy costs, loss reserves and  allowances, and product fees, and how these processes account for  different risks, we reviewed relevant requirements and guidance. This  included the Federal Credit Reform Act of 1990; the Office of  Management and Budget (OMB) Circular No. A-11 (Preparation,  Submission, and Execution of the Budget); the Statement of Federal  Financial Accounting Standards No. 2 (Accounting for Direct Loans and  Loan Guarantees); the Federal Accounting Standards Advisory Board’s  Federal Financial Accounting and Auditing Technical Release 6  (Preparing Estimates for Direct Loan and Loan Guarantee Subsidies  under the Federal Credit Reform Act); and the Organisation for Economic  Cooperation and Development Arrangement on Officially Supported  Export Credits (OECD Arrangement). We identified types of risks  applicable to Ex-Im by reviewing Ex-Im’s documents, including annual  reports and policy manuals, as well as prior GAO work on credit programs  and risk management. To examine how Ex-Im accounts for these risks,  we reviewed information on the tools and processes Ex-Im uses to  determine subsidy costs and loss reserves and allowances, including Ex- Im’s loss estimation model. We reviewed documentation on the structure  of the model, updates made to the model in 2012, and findings and  recommendations made by the Ex-Im IG and Ex-Im’s independent  financial statement auditor about the model. We also reviewed relevant  workpapers from the independent auditor’s audit of Ex-Im’s 2012 financial  statements. We also reviewed Congressional Budget Office and OMB  reports on discounting methodologies for federal credit programs. To  obtain additional information about Ex-Im’s subsidy cost and loss reserve  and allowance calculations, we interviewed Ex-Im and Ex-Im IG officials,  representatives from Ex-Im’s independent financial statement auditor, and  OMB officials responsible for approving Ex-Im’s subsidy cost estimation  methodology. In addition, we spoke with other federal agencies that  provide international credit—including the Small Business Administration,  the Department of Agriculture’s Foreign Agricultural Service and Farm  Service Agency, and the Overseas Private Investment Cooperation  (OPIC)—and the four foreign ECAs cited previously about their processes  for estimating program costs and reserving for future losses. To obtain  information about how Ex-Im sets product fees and what risks they  account for, we reviewed fee-setting requirements contained in the OECD  Arrangement and Ex-Im analyses used as a basis to adjust fees for  different products. An assessment of the appropriateness of the fee levels  resulting from the OECD Arrangement was outside the scope of our  review. We interviewed Ex-Im officials and officials from the U.S.  Department of the Treasury responsible for negotiating for the United  States at OECD, including negotiations on minimum premiums. We also  discussed with the four foreign ECAs how they set product fees.

To assess how Ex-Im’s financial portfolio has performed and the  budgetary impact of its programs, we reviewed agency data and  documentation—including Ex-Im performance data, annual reports,  financial statements, and quarterly default reports—and information  contained in the President’s budgets and Federal Credit Supplements.  Specifically, to determine how Ex-Im’s portfolio has performed, we  analyzed data Ex-Im compiled from the Ex-Im Bank Reporting System on  active transactions—including authorized and disbursed amounts,  amounts in arrears, claims paid, and recoveries—to calculate overall  default rates and default rates by product type. We examined end-of- fiscal-year data for 2006 through 2012 and data as of December 31,  2012. We reviewed federal banking regulator guidance on default  monitoring, including vintage analysis, and determined whether Ex-Im  conducted or maintained data to perform such an analysis. In addition, we  reviewed data on the ratio of Ex-Im’s impaired assets to total exposure  from 2008 through 20012. To determine the budgetary impact of Ex-Im’s  programs, we reviewed Ex-Im’s analysis of the funds it has been  appropriated and the funds it has sent to the U.S. Treasury (the net of  upward and downward credit subsidy reestimates, cancelled authority,  returned collections, and rescissions) from 1992 through 2012. To do this,  we compared Ex-Im’s analysis to data contained in appropriation acts, the  President’s budgets, and Ex-Im’s financial statements for the same years.

Based on this comparison, we determined that Ex-Im’s analysis was  reasonable. Additionally, we analyzed Ex-Im’s annual credit subsidy  reestimates for 1992 through 2012 using information in the President’s  budgets. We discussed the performance and budget data with  knowledgeable Ex-Im officials to ensure that we interpreted the data  correctly.

To assess the extent to which Ex-Im has a comprehensive risk- management framework, we reviewed the practices Ex-Im uses to  manage risks at the transaction, portfolio, and agency level. At the  transaction level, we reviewed Ex-Im’s policies and procedures related to  the underwriting, monitoring and restructuring, and claims and recovery  functions. We also interviewed Ex-Im senior management and division  managers responsible for various products about these procedures. To  assess how Ex-Im manages risks at the portfolio level, we reviewed a  September 2012 report by the Ex-Im IG on Ex-Im’s portfolio risk  management and followed up with Ex-Im officials to determine the actions  they had taken in response to the report’s recommendations. We also  identified relevant criteria in GAO’s Standards for Internal Control in the  Federal Government and Internal Control Management and Evaluation  Tool and documents from financial industry groups describing sound   Additionally, we discussed  practices for managing financial portfolios.portfolio and general risk-management practices with officials from the  federal credit agencies and foreign ECAs cited previously, a  representative from the International Association of Credit Portfolio  Management, and Ex-Im officials. Finally, we reviewed information related  to potential operational risks stemming from Ex-Im’s increasing business  volume and workload and identified relevant criteria from our internal  control standards. We limited our work in this area to Ex-Im’s human  capital management. Specifically, we analyzed Ex-Im data on the number  of full-time equivalents and the number and dollar volume of transactions  authorized from 2006 through 2012. We also reviewed Ex-Im’s Human  Capital Plan for 2009-2012, Reauthorization Act of 2012 Business Plan,  and congressional budget justifications from 2008 through 2013, and  internal Ex-Im analyses of agency workloads. Additionally, we interviewed  Ex-Im officials responsible for resource management.

To assess the reliability of the data provided by Ex-Im, including exposure  and authorization amounts and performance statistics, we (1) reviewed  information related to data elements, system operations, and controls; (2)  performed electronic testing for obvious errors in accuracy and  completeness; (3) compared data to published documents; and (4)  interviewed Ex-Im officials knowledgeable about the data. To assess the  reliability of data we used to describe capital market conditions and U.S.  exports, we (1) reviewed related documentation, (2) interviewed  knowledgeable officials about the data, and (3) performed electronic  testing and inspected the data for missing observations and outliers. We  concluded that the data elements we used were sufficiently reliable for  purposes of describing Ex-Im’s growth and financial performance.

We conducted this performance audit from June 2012 to March 2013 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

section_title: Appendix II: Comments from the U.S. Export- Import Bank

section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact

section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Steve Westley, Assistant  Director; Daniel Alspaugh; Kathryn Bolduc; Marcia Carlsen; Pamela  Davidson; Cole Haase; Michael Hoffman; Christine Houle; Susan Irving;  Risto Laboski; Felicia Lopez; Colleen Moffatt Kimer; Melissa Kornblau;  Robert Pollard; Barbara Roesmann; Jessica Sandler; Eva Su; and Celia  Thomas made key contributions to this report.


Question-summary annotations: questions: question: What do Ex-Im's processes account for?
answer: Ex-Im's processes for determining credit subsidy costs, loss reserves and allowances, and fees account for multiple risks.

question: How does Ex-Im make calculations?
answer: To implement the Federal Credit Reform Act of 1990 and other requirements, Ex-Im calculates subsidy costs and loss reserves and allowances with a loss model that uses historical data and takes credit, political, and other risks into account.
child_questions: question: What factors does Ex-Im account for in its calculations?
answer: Consistent with industry practices, Ex-Im added factors to the model in 2012 to adjust for circumstances that may cause estimated credit losses to differ from historical experience.

question: How might Ex-Im's model be improved?
answer: Opportunities exist to further improve the model. For example, Ex-Im uses a 1-year forecast of certain bond defaults to predict possible changes in loss estimates from changed economic conditions. However, a short-term forecast may not be appropriate for adjusting estimated defaults for longer-term products.

question: What are Ex-Im's fees guided by?
answer: Ex-Im's fees are generally risk-based and, for medium- and long-term products (about 85 percent of Ex-Im's exposure), guided by international agreements that set minimum fees that account for credit and political risk.

questions: question: What did Ex-Im report as of December 2012?
answer: As of December 2012, Ex-Im reported an overall default rate of less than 1 percent.

question: What has Ex-Im not maintained data on?
answer: However, Ex-Im has not maintained data needed to compare the performance of newer books of business with more seasoned books at comparable points in time, a type of analysis recommended by federal banking regulators.
child_questions: question: How might this affect the precision of Ex-Im's model?
answer: Also, without point-in-time data showing when defaults occur, the precision of Ex-Im's loss model may be limited.

question: Why is Ex-Im's long-term impact uncertain?
answer: Ex-Im has been self-sustaining since 2008 and has generated receipts for the government. But, because Ex-Im's portfolio contains a large volume of recent transactions, the long-term impact of this business on default rates and the federal budget is not yet known.

questions: question: What has Ex-Im been developing?
answer: Ex-Im has been developing a more comprehensive risk-management framework but faces operational risks. Ex-Im manages credit and other risks through transaction underwriting, monitoring, and restructuring. Ex-Im also started addressing recommendations by its Inspector General (IG) about portfolio stress testing, thresholds for managing portfolio concentrations, and risk governance.
child_questions: question: What did GAO's review of internal control standards indicate about the IG's recommendations?
answer: GAO’s review of internal control standards and industry practices indicates that the IG’s recommendations represent promising techniques that merit continued attention.

question: What has Ex-Im not yet addressed?
answer: Ex-Im has not yet made plans to report its stress test scenarios and results to Congress, although doing so would aid congressional oversight and be consistent with internal control standards for effective external communication.

question: What risks does Ex-Im face?
answer: Ex-Im faces potential operational risks because the growth in its business volume has strained the capacity of its workforce.
child_questions: question: How has Ex-Im responded to these concerns?
answer: Ex-Im has determined that it needs more staff, but it has not formally determined the level of business it can properly manage.

question: What do GAO's internal control standards state?
answer: GAO internal control standards state that agencies should develop a risk-management approach based on how much risk can be prudently accepted.
child_questions: question: How might the lack of such an approach negatively affect Ex-Im?
answer: Without benchmarks to determine when workload levels have created too much risk, Ex-Im’s ability to manage its increased business volume may be limited.