In the 1970s and 1980s, DOD guaranteed loans issued for weapons exports and incurred significant costs when developing countries were unable to repay. Between 1974 and 1984, almost all foreign military financing took the form of guaranteed loans provided through the U.S. government’s Federal Financing Bank. In the global recession of the 1980s, repayment of these loans was difficult for developing countries. Congress authorized debt refinancing and debt reduction plans to mitigate these problems. By 1990, DOD changed its financing focus from guarantees to predominantly grants. DOD’s foreign military financing currently consists of grants and also loans subject to the Federal Credit Reform Act of 1990. As worldwide military sales have declined in recent years, competition in arms sales has intensified among major weapon suppliers. U.S. defense companies have been concerned that they have been at a competitive disadvantage because other exporting nations provided government-backed financing, while the United States did not. Although only one of many variables in a buyer’s decision, official export financing support can be of particular importance in an individual sale, such as when private institutions are unwilling to offer long-term financing without a guarantee. The Secretary of Defense assigned responsibility for the new loan guarantee program to the Under Secretary of Defense (Acquisition and Technology), who placed the program in the office of the Deputy Under Secretary of Defense for International and Commercial Programs. However, as part of the Secretary of Defense’s 1997 Defense Reform Initiative to restructure parts of DOD, responsibility for the program was planned to transfer to the Defense Security Cooperation Agency (DSCA) in fiscal year 1999. Under the DELG Program, the Secretary of Defense may issue guarantees against possible losses of principal and interest for loans provided by private sector institutions to certain eligible sovereign nations. DOD guarantees defense export loans for up to the lesser of 85 percent of the contract value or 100 percent of U.S. content provided that the U.S. portion of the production cost of exported items is greater than 50 percent. The program covers eligible transactions under both the Foreign Military Sales Program, administered by DOD, and U.S. defense companies’ direct sales that are licensed by the U.S. Department of State. Eligibility is limited to countries meeting criteria defined by the program’s authorizing legislation. As of January 1997, 39 countries were eligible for the DELG Program. DELG Program financing terms include disbursement periods, during which only interest is charged, that extend as long as 5 years and repayment periods up to 12 years. Interest, based on a lender’s cost of funds plus an agreed percentage, will accrue on the outstanding balance of the loan during the disbursement period and will be paid at a minimum of every 6 months. Repayment of principal must begin within 6 months of the end of the disbursement period. DOD determines the repayment period based on the contract value, the useful life of the item, and the purchasing country. The borrowing nation must accept the loan as sovereign debt and pay at least 15 percent of the contract price to the supplier in cash, prior to disbursement of the guaranteed loan amount or in incremental installments. DOD may respond to an application for a DELG loan guarantee in two phases as requested by the applicant (see fig.1). In the first phase, DOD issues a letter of interest providing nonbinding notification that it is willing to guarantee a loan and estimates the costs to the borrower. This notification does not obligate DOD to provide a guarantee. In the second phase, DOD issues a binding commitment to guarantee the eligible loan. However, applicants may request final commitment from DOD without first obtaining a letter of interest. Consistent with congressional intent, DOD designed the DELG Program to operate through various user fees to cover its operating costs and the risk of potential default on loan payments by the borrowing nation. However, the program has collected little money in fees because most eligible countries have not participated. In the authorizing legislation, Congress limited the number of eligible countries to countries that are major allies or emerging democracies. Industry and banking officials we spoke with said that most of the eligible countries can obtain financing at a lower cost or, alternatively, they find the program unaffordable. Therefore, countries make little use of the DELG Program. In addition, it is unclear what impact export financing arrangements have on export sales, because other factors may also affect a purchasing country’s decision on from whom to buy. The DELG Program was intended to be self-sustaining and therefore user fees to borrowing nations were set at levels expected to cover estimated program costs. The borrower pays fees to cover administrative costs and an exposure fee that reflects the risk of default. DOD calculates the exposure fee based on the loan’s repayment term, its disbursement schedule, the country’s risk rating, and the guaranteed loan’s interest rate. By law, the exposure fee must be paid proportionately as the guaranteed loan is disbursed and may not be included in the guaranteed loan amount. To initiate the program, DOD was authorized to provide $500,000 from its operating funds for reimbursable start-up costs. The authorizing legislation provided that user fees for the DELG Program would be used to reimburse the start-up costs. As shown in figure 2, borrowers pay administrative fees to a program account that is recorded on budget and an exposure fee to a financing account that is nonbudgetary and is used to record the cash flows associated with the loan guarantee over its life. In the case of defaults, the reserves held in the financing account are used to make claim payments to the lending institution. If exposure fee estimates are accurate, the financing account will have exactly the reserves needed to cover any defaults that occur. If exposure fees are not estimated correctly and losses occur, additional funds from the general fund may be necessary to cover losses. Since its inception, the DELG Program has issued one loan guarantee valued at about $16.7 million to support a U.S. company’s licensed direct commercial sale of unmanned air vehicle and moving target simulator systems to Romania. In early 1997, AAI Corporation, a U.S. company, conducted negotiations with the Romanian government for the contract. According to company officials, financing was not a factor in winning the contract award. The Romanian government had originally planned to pay for the purchase from its budget but requested financing during contract negotiations. As a result, AAI Corporation sought a loan that would be guaranteed by the DELG Program. When the loan guarantee was approved, the exposure risk fee was calculated at 21.23 percent of the guaranteed principal amount of about $16.7 million, a fee of about $3.5 million. Disbursement of the loan began in July 1998, and it is planned to conclude in March 1999 according to DOD officials. The Romanian government will have 5 years to repay the loan. Besides guaranteeing one loan, the DELG Program has issued preliminary notifications that it is willing to guarantee loans for nine other transactions. These are valid for 6 months and then may be renewed. According to a DELG program official, some of the nine letters of interest are no longer valid. DOD officials said that they do not monitor the status of contract awards and, therefore, do not know whether any of the nine transactions will result in an eventual loan guarantee. However, if any of the letters of interest resulted in a guarantee, then the DELG Program would receive additional fees. Based on the letters already issued, the DELG Program has indicated its willingness to guarantee loans to Greece, New Zealand, South Korea, Spain, Thailand, and Turkey. The aggregate DELG guarantee amount for the nine transactions is about $4.5 billion. Examples of equipment covered by the potential loan guarantees are radar systems and major platforms such as military aircraft. Some DOD and industry officials stated that the letters of interest are used as a marketing tool so that the potential purchaser can compare the DELG terms and conditions with other available financing options. As authorized, the Secretary of Defense made available $500,000 for expenses directly related to the administration of the DELG Program. This money, which came from DOD appropriated funds, was used for a contract with a consulting firm to implement the program. The start-up costs are to be reimbursed to DOD’s operations and maintenance fund if and when the program has collected sufficient fees. To date, the start-up costs have not been reimbursed, and the contract with the consulting firm terminated at the end of fiscal year 1998. DOD officials who provided policy oversight for the program indicated that they did not charge time specifically to a DELG account and that most of the daily operations, such as responding to program inquiries and drafting letters of interest, were covered by the outside consulting firm. About $125,000 in fees were collected as of October 1998. The funds are being held in a special receipt account until they are expended. Table 1 shows the types of fees charged to administer the program and the amount collected. Long-term viability of the program, as currently structured, depends on a level of business that generates sufficient funds to cover daily program operations and the likelihood of potential defaults. However, the program’s ability to attract additional business is unclear because, according to banking and industry officials with whom we spoke, the program is not cost-effective for most of the 39 eligible countries. The majority of these countries could either pay for defense equipment from their own budgets or obtain favorable financing from the private sector lending community. The countries with the highest risk of default on loans are the most likely to be interested in the program because they can obtain longer terms and lower interest rates than in the commercial market. Banking and industry officials also said that many banks do not finance defense exports as a matter of policy, and those that do are not likely to provide long financing terms for high risk countries.