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Office of Budget

Fiscal Year 2004 Performance and Accountability Report
Published November 15, 2004

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7. Direct Loans and Loan Guarantees

Direct loan obligations and loan guarantee commitments made after 1991, and the resulting direct loans or loan guarantees, are governed by the Federal Credit Reform Act of 1990. The Act provides that the present value of the subsidy costs associated with direct loans and loan guarantees be recognized as a cost in the year the direct or guaranteed loan is disbursed. Direct loans are reported net of an allowance for subsidy costs at present value, and loan guarantee liabilities are reported at present value. Pre-1992 direct loans and loan guarantees are reported under the allowance for loss method. The nominal amount of the direct loan is reduced by an allowance for uncollectible amounts, and the liability for loan guarantees is the amount VA estimates will most likely require a future cash outflow to pay defaulted claims.

Interest is accrued on VA-owned loans by computing interest on a loan-by-loan basis at the end of the month and recording the amount owed as an accrual.

The recorded value of loans receivable, net, and the value of assets related to direct loans are not the same as the proceeds that VA would expect to receive from selling its loans. VA operates the following direct loan and loan guaranty programs:

  • Vocational Rehabilitation and Employment.
  • Education.
  • Insurance.
  • Loan Guaranty.

Under the Loan Guaranty Program, a loan may be made to an eligible veteran by an approved private sector mortgage lender. VA guarantees payment of a fixed percentage of the loan indebtedness to the holder of such a loan, up to a maximum dollar amount, in the event of default by the veteran borrower. Occasionally, a delinquency is reported to VA and neither a realistic alternative to foreclosure is offered by the loan holder nor is VA in a position to supplementally service the loan. In such cases, VA determines, through an economic analysis, whether VA will authorize the holder to convey the property securing the loan (foreclosure) or pay the loan guarantee amount to the holder.

Direct Loans

Loans receivable related to direct loans represent the net value of assets related to acquired pre-1992 and post-1991 direct loans. For pre-1992 loans, VA employs the allowance for loss method in which the assets are offset by an allowance for loan losses (estimated uncollectible loans). For post-1991 loans, the assets are offset by an allowance for subsidy costs. An analysis of loans receivable and the nature and amounts of the subsidy costs associated with the direct loans are provided in the tables that follow:

Loans Receivable and Related Foreclosed Property From Direct Loans as of September 30, 2004
Loans Receivable Gross Interest Receivable Allowance for Loan Losses Foreclosed Property Value of Assets Related to Loans
Direct Loans Obligated Prior to FY 1992 (Allowance for Loss Method) $ 82 $ 7 $ - $ - $ 89
Direct Loans Obligated after 1991 1,051 29 (166) 93 1,007
Insurance Policy Loans 716 17 - - 733
Total Loans Receivable and Related Foreclosed Property from Direct Loans, Net $ 1,829
Loans Receivable and Related Foreclosed Property From Direct Loans as of September 30, 2003
Loans Receivable Gross Interest Receivable Allowance for Loan Losses Foreclosed Property Value of Assets Related to Loans
Direct Loans Obligated Prior to FY 1992 (Allowance for Loss Method) $ 114 $ 15 $ - $ - $ 129
Direct Loans Obligated after 1991 1,585 29 1,136 87 2,837
Insurance Policy Loans 770 19 - - 789
Total Loans Receivable and Related Foreclosed Property from Direct Loans, Net $ 3,755

Direct Loans Disbursed

The total amount of direct loans disbursed for the years ended September 30, 2004 and 2003, was $123 and $563 million, respectively.

Provision for Losses on Pre-1992 Loans

The present value of the cost VA will bear as loans already guaranteed default is an element of the mortgage loan benefit that VA provides to veterans. This cost is reflected in the financial statements as an offset to the value of certain related assets.

The provision for losses on vendee loans is based upon historical loan foreclosure results applied to the average loss on defaulted loans. The calculation is also based on the use of the average interest rate of U.S. interest-bearing debt as a discount rate on the assumption that VA's outstanding guaranteed loans will default over a 12-year period. For FY 2004, VA determined that these vendee loans have sufficient equity due to real estate appreciation and buy-down of principal, to minimize or eliminate any potential loss to VA. The components of the provision are as follows:

Provision for Loss as of September 30,
2004 2003
Offsets Against Foreclosed Property Held for Sale 10 8
Total Provision for Loss $ 10 $ 8

Subsidy Expense for Post-1991 Direct Loans

Pursuant to the Credit Reform Act, all direct loans established after September 30, 1991, will be subsidized. The subsidy expense for direct loans is as shown:

Direct Loan Subsidy Expense for the years ended September 30,
2004 2003

* Includes approximately $50,000 and $42,000 in defaults and other expenses for the Vocational Rehabilitation Program for FY 2004 and 2003, respectively.

** "Fees" expense for direct loans includes estimated down payments and other fees collected when homes are sold with vendee financing.

*** The "Other" expense for direct loans includes the estimated loss of scheduled principal and interest when vendee loans are sold.

Interest Differential $ (6) $ (55)
Defaults* 3 12
Fees** 0 (9)
Other*** 4 44
Subtotal 1 (8)
Interest Rate Reestimates 473 (178)
Technical Reestimates 922 (44)
Total Direct Loans $ 1,396 $ (230)

Subsidy Rates for Direct Loans by Component

The subsidy rates disclosed below pertain only to the current year cohorts. These rates cannot be applied to the direct loans disbursed during the current reporting year to yield the subsidy expense. The subsidy expense for new loans reported in the current year could result from disbursements of loans from both current year cohorts and prior year(s) cohorts. The subsidy expense reported in the current year also includes reestimates.

Subsidy rates for direct loans
Interest Differential (17.19%)
Defaults 12.8%
Fees (0.44%)
Other 7.28%

Allowance for Subsidy for Direct Loans (Post-1991)

VA reports the allowance for subsidy for direct loans, subject to Credit Reform requirements. For these loans, the allowance for subsidy represents the present value of the estimated net cash flows to be paid by VA as a result of a disbursed direct loan. VA disburses a direct loan and receives an allowance for subsidy along with borrowing from Treasury. For FY 2004, the subsidy rate for October through December is (11.16) and the subsidy rate for January through September is (2.48). In FY 2003 the rate was 0.86 percent. The allowance for subsidy as of September 30, 2004 and 2003 is $166 and ($974) million, respectively.

Schedule for Reconciling Subsidy Cost Allowance Balances
Beginning Balance, Changes and Ending Balance FY 2004 FY 2003
Beginning balance of the allowance $ (1,136) $ (853)
Subsidy expense for direct loans disbursed during the reporting years by component:
Interest subsidy costs (6) (55)
Default costs (net of recoveries) 3 12
Fees and other collections 0 (9)
Other subsidy costs 4 44
Total of the above subsidy expense components 1 (8)
Adjustments:
Loan modification 0 0
Fees received 1 11
Foreclosed property acquired (21) (5)
Loans written off (9) (6)
Subsidy allowance amortization (65) (53)
Other 0 0
Ending balance of the allowance before reestimates (1,229) (914)
Subsidy reestimates by component
Interest rate reestimate 473 (44)
Technical/default reestimate 922 (178)
Total of the above reestimate components 1,395 (222)
Ending balance of the allowance $ 166 $ (1,136)

Loan Guarantees

Loans receivable related to loan guarantees represent the net value of assets related to pre-1992 and post-1991 defaulted guaranteed loans and non-defaulted guaranteed loans. For pre-1992 loans, VA employs the allowance for loss method in which the assets are offset by an allowance for loan losses (estimated uncollectible loans). An analysis of loans receivable, loan guarantees, the liability for loan guarantees, and the nature and amounts of the subsidy costs associated with loan guarantees are provided in the tables that follow:

Loans Receivable and Related Foreclosed Property from Loan Guarantees as of September 30,
2004 Loans Receivable Gross Interest Receivable Allowance for Loan Losses Foreclosed Property Value of Assets Related to Loans
Defaulted Guaranteed Loans Pre-1992 Guarantees 129 1 (121) 45 54
Defaulted Guaranteed Loans Post-1991 - - - 1,071 1,071
Total Loans Receivable and Related Foreclosed Property from Loan Guarantees $ 1,125
Loans Receivable and Related Foreclosed Property from Loan Guarantees as of September 30,
2003 Loans Receivable Gross Interest Receivable Allowance for Loan Losses Foreclosed Property Value of Assets Related to Loans
Defaulted Guaranteed Loans Pre-1992 Guarantees 147 4 (138) 46 59
Defaulted Guaranteed Loans Post-1991 - - - 841 841
Total Loans Receivable and Related Foreclosed Property from Loan Guarantees $ 900
Total Loans Receivable and Related Foreclosed Property, Net for the years ended September 30,
2004 2003
Total Direct Loans $ 1,829 $ 3,755
Total Guaranteed Loans 1,125 900
Total Loans Receivable and Related Foreclosed Property, Net $ 2,954 $ 4,655

Foreclosed Property

Prior to the foreclosure of property secured by a VA loan, VA obtains an independent appraisal of the property. This appraisal is reviewed by VA staff who make a determination of the fair market value. To determine the net value of the property, VA expenses such as costs for acquisition, management, and disposition of the property, as well as estimated losses on property resale, are subtracted from the estimated fair market value. As of September 30, 2004 and 2003, the estimated number of residential properties in VA's inventory was 15,539 and 11,872, respectively. For FY 2004 and FY 2003, the average holding period from the date properties were conveyed to VA until the properties were sold was estimated to be 10.1 months and 8.9 months, respectively. The number of properties for which foreclosure proceedings are in process is estimated to be 10,355 and 10,513 as of September 30, 2004 and 2003, respectively.

Guaranteed Loans as of September 30,
2004 2003
Guaranteed Loans Outstanding:
Outstanding Principal Guaranteed Loans, Face Value $ 207,374 $ 213,248
Amount of Outstanding Guarantee 64,683 67,654
New Guaranteed Loans Disbursed:
Outstanding Principal Guaranteed Loans, Face Value $ 44,130 $ 63,255
Amount of Outstanding Guarantee 12,643 18,245
Liabilities for Loan Guarantees Post 1991 (Present Value) $ 4,740 $ 4,756

Guaranty Commitments

As of September 30, 2004, VA had outstanding commitments to guarantee loans that will originate in FY 2005. The number and amount of commitments could not be determined, as VA has granted authority to various lenders to originate VA loans that meet established criteria without prior VA approval. Nearly 90 percent of VA's guaranteed loans originate under this authority.

Subsidy Expense for Post-1991 Loan Guarantees

Pursuant to the Credit Reform Act, guaranteed loans closed after September 30, 1991, will be subsidized. The subsidy expense for loan guarantees related to the Loan Guaranty Program is as shown:

Guaranteed Loan Subsidy Expenses for the years ended September 30,
2004 2003

* The "Fees" expense includes estimated up-front fees collected when the loans are guaranteed and the present value of estimated annual fees from loan assumptions.

** The "Other" expense for guaranteed loans includes estimated recoveries on defaults through the sales of foreclosed properties.

Defaults $ 652 $ 1,678
Fees* (470) (1,145)
Other** 0 0
Subtotal 182 533
Interest Rate Reestimates (241) (471)
Technical Reestimates (542) (1,407)
Total Guaranteed Loan Subsidy Expense $ (601) $ (1,345)
Loan Sale-Guaranteed Loan Subsidy Expense for the years ended September 30,
2004 2003
Defaults $ 19 $ 14
Other (2) 0
Subtotal 17 14
Interest Rate Reestimates 102 (50)
Technical Reestimates 80 (109)
Total Loan Sale-Guaranteed Subsidy Expense $ 199 $ (145)
Total Subsidy Expense for the years ended September 30,
2004 2003
Total Direct Loans $ 1,396 $ (230)
Total Guaranteed Loans (601) (1,345)
Total Sale Loans 199 (145)
Total Subsidy Expense $ 994 $ (1,720)

Subsidy Rates for Loan Guarantees by Component

The subsidy rates disclosed below pertain only to the current year cohorts. These rates cannot be applied to the guarantees of loans disbursed during the current reporting year to yield the subsidy expense. The subsidy expense for new loan guarantees reported in the current year could result from disbursements of loans from both current year cohorts and prior year(s) cohorts. The subsidy expense reported in the current year also includes reestimates.

Subsidy Rates for Loan Guarantees
Defaults 1.85%
Fees (1.33%)
Other 0

Loan Sales

VA continues to have vendee loan sales to reduce the administrative burden of servicing vendee loans. During the period FY 1992 through FY 2004, the total loans sold amounted to $13.8 billion. Under the sale of vendee loans, certificates are issued pursuant to the Pooling and Servicing Agreement (the Agreement) among VA, the Master Servicer, and the Trustee. On the closing date of the certificates, VA transfers its entire interest in the related loans to the Trustee for the benefit of the related certificate holders pursuant to the Agreement. Under the Agreement, the Trust will issue certificates backed by mortgage loans and installment contracts. The Trust owns the mortgage loans and other property described in the offering and the Trust makes elections to treat certain of its assets as one or more Real Estate Mortgage Investment Conduits (REMIC) for U.S. Federal income tax purposes. The certificates represent interests in the assets of the Trust and are paid from the Trust's assets. The certificates are issued as part of a designated series that may include one or more classes. VA guarantees that the investor will receive full and timely distributions of the principal and interest on the certificates and that guaranty is backed by the full faith and credit of the Federal Government.

VA may terminate the Trust, causing the early retirement of certificates, by purchasing all of the Trust's assets on any distribution date on or after the distribution date on which the current aggregate principal balance of all principal certificates is less than 1 percent of the original aggregate principal balance, or if VA determines that the Trust's REMIC status has been lost or a substantial risk exists that such status will be lost. In the event of termination, the certificate holder will be entitled to receive payment for the full principal balance of the certificates plus any accrued interest and unpaid interest through the related distribution date.

The Agreement requires the mortgage loans to be serviced generally in compliance with Fannie Mae and Freddie Mac standards and consistent with prudent residential mortgage loan servicing standards generally accepted in the servicing industry. For mortgage loans sold during FY 2004, servicing was performed by Countrywide Home Loans, Inc. (Master Servicer). The Master Servicer is responsible for the performance of all of the servicing functions under the Agreement. The Master Servicer is entitled to be compensated by receiving

  1. a service fee of 0.2075 percent per annum payable monthly and calculated by multiplying the interest payment received by a fraction, the numerator of which is 0.2075 percent and the denominator of which is the mortgage interest rate on such loan;
  2. earnings on investment of funds in the certificate account;
  3. and all incidental fees and other charges paid by the borrowers and a portion of the liquidation proceeds in connection with the liquidated loans.

VA completed one sale during FY 2004 and one sale during FY 2003 totaling approximately $298 million and $283 million of vendee loans, respectively. The components of the vendee sales are summarized in the tables below:

Loan Sales Years ended September 30,
2004 2003
Loans Receivable Sold $ 298 $ 283
Net Proceeds From Sale 308 299
Loss (Gain) on Receivables Sold $ (10) $ (16)

Outstanding Balance of Loan Sale Guarantees

All loans sold under the American Housing Trust (AHT VI through AHT XI) and the Vendee Mortgage (VMT 92-1 through 03-1) programs carry a full government guarantee. The outstanding balance for guaranteed loans sold is summarized in the table below:

Guaranteed Loans Sold as of September 30,
2004 2003
Outstanding Balance Guaranteed Loans Sold, Start of Year $ 5,569 $ 7,406
Sold to the Public 298 283
Payments, Repayments, and Terminations (1,679) (2,120)
Outstanding Balance Guaranteed Loans Sold, End of Year $ 4,188 $ 5,569

Liability for Loan Sale Guarantees (Post-1991)

VA reports the liability on the guarantee of loans sold under the Vendee Mortgage Trust and American Housing Trust programs, subject to Credit Reform requirements. For these loans, the guaranteed loan sale liability represents the present value of the estimated net cash flows to be paid by VA as a result of the guarantee. These sales contain two types of guarantees for which VA pays net cash flow. VA guarantees that the principal and interest payment due on a sold loan will be paid by the 15th of each month. If not paid by the borrower, VA allows the loan servicer to take funds from cash reserve accounts for the deficient amount. VA also guarantees the loan against loss at foreclosure. VA will not buy back the loans but will pay off the loan loss and foreclosure expenses. The subsidy rate for FY 2004 is 5.65 percent. For FY 2003 the subsidy rate was 5.06 percent. The liability for loan sale guarantees as of September 30, 2004 and 2003 is $255 and $77 million, respectively.

Schedule for Reconciling Loan Sale Guarantee Liability Balances
Beginning Balance, Changes and Ending Balance FY 2004 FY 2003
Beginning balance of the liability $ 77 $ 210
Subsidy expense for guaranteed loans disbursed during the reporting years by component:
Interest subsidy costs - -
Default costs (net of recoveries) 19 14
Fees and other collections - -
Other subsidy costs (2) -
Total of the above subsidy expense components 17 14
Adjustments:
Loan guarantee modifications - -
Fees received - -
Interest supplements paid - -
Foreclosed property and loans acquired - -
Claim payments to lenders (36) (19)
Interest accumulation on the liability balance 6 15
Other 9 16
Ending balance of the liability before reestimates 73 236
Subsidy reestimates by component
Interest rate reestimate 102 (50)
Technical/default reestimate 80 (109)
Total of the above reestimate components 182 (159)
Ending balance of the liability $ 255 $ 77

Liability for Loan Guarantees (Post-1991)

VA reports the liability on the guarantee of loans, subject to Credit Reform requirements. For these loans, the guaranteed loan liability represents the present value of the estimated net cash flows to be paid by VA as a result of a defaulted loan guarantee. VA guarantees the loan against loss at foreclosure for which VA pays net cash flow up to a legally specified maximum based on the value of individual loans. VA will pay the lender the guarantee and foreclosure expenses. If an agreement can be made with the veteran, VA may acquire the loan by refunding the lender for the loan. The FY 2004 and FY 2003 subsidy rate is 0.52 and 0.81 percent, respectively. The liability for loan guarantees as of September 30, 2004 and 2003 is $4,485 and $4,679 million, respectively.

Schedule for Reconciling Loan Guarantee Liability Balances
Beginning Balance, Changes and Ending Balance FY 2004 FY 2003
Beginning balance of the liability $ 4,679 $ 5,452
Subsidy expense for guaranteed loans disbursed during the reporting years by component:
Interest subsidy costs - -
Default costs (net of recoveries) 652 1,677
Fees and other collections (469) (1,145)
Other subsidy costs - -
Total of the above subsidy expense components 183 532
Adjustments:
Loan guarantee modifications - -
Fees received 482 549
Interest supplements paid - -
Foreclosed property and loans acquired 67 189
Claim payments to lenders (406) (449)
Interest accumulation on the liability balance 263 284
Other - -
Ending balance of the liability before reestimates 5,268 6,557
Subsidy reestimates by component
Interest rate reestimate (241) (471)
Technical/default reestimate (542) (1,407)
Total of the above reestimate components (783) (1,878)
Ending balance of the liability $ 4,485 $ 4,679

Estimation Technique Change

VA used the balances approach method for the 2004 financial statement reestimates to replace the traditional approach method used in FY 2003 to more accurately project the remaining financial requirements for cohorts being reestimated in the Direct Loan Financing Account (DLFA, 36X4127) and the Loan Sales Securities Account (LSSA, 36X4124). By comparing with the traditional method, the use of the balances approach results in a net difference of $343.6 million less for all reestimated cohorts for the DLFA. The net difference for the LSSA is $100.1 million more for all reestimated cohorts. As a result of the change of the calculator, future reestimates will be significantly less.

Administrative Expense

Administrative expense on direct and guaranteed loans for the years ended September 30, 2004 and 2003, was $154 and $168 million, respectively.