that are owed or guaranteed by foreign governments. Rather than recognize that a loan has gone bad, the EXIMBANK proceeds

through rescheduling after rescheduling.

Fair presentation of loans receivable requires a recognition in the accounts of the diminished value of loans through a charge against current year's income and a corresponding increase in an allowance for loan losses. EXIMBANK has not recognized that its loans are impaired--even when the foreign governments repudiate the debt. The result, in our opinion, is a loan balance which is not fully collectible and, accordingly, is overstated. As of September 30, 1984, we estimated the loss in the EXIMBANK's $17.5 billion loan portfolio to be $1 to $1.5 billion. How can we expect the private sector auditors to take a hard line on uncollectible loans if we, as EXIMBANK's auditors, do not set this kind of example?

FSLIC AUDIT

In the case of FSLIC, our 1984 audit also revealed problems with asset evaluation. In GAO's opinion, FSLIC's 1984 financial statements were subject to uncertain net realizable values for claims against assets acquired from three large institutions-Empire Savings and Loan, Mesquite, Texas; Knox Federal Savings and Loan, Knoxville, Tennessee; and San Marino Savings and Loan, San Marino, California--that were closed in 1984. At December 31, 1984, FSLIC held $1.3 billion in claims against the assets of the three institutions, and had established a $470 million allowance for loss based on a preliminary estimate that did not include all possible costs. The recency of the San

Marino and Knox Federal failures in late 1984, along with inadequate loan records and pending and possible litigation affecting the three institutions, precluded determining a better estimate of the ultimate collectibility of the claims. Given these uncertainties, we were not able to satisfy ourselves that FSLIC's allowance for loss estimate was reasonable.

To understand the problems encountered in evaluating the net realizable value of these assets, one should bear in mind the conditions that existed at these institutions prior to their failure. A common problem at poorly managed institutions is inadequate or nonexistent recordkeeping, questionable

accounting, and over-valued collateral.

These conditions make

it nearly impossible to quickly determine the true value of an

institution's assets.

Our current FSLIC audit

As part of our audit of FSLIC's 1985 financial statements, which is currently in progress, we have continued to question the value of assets acquired through default prevention and liquidation activities. In response to our management letter to Chairman Gray at the conclusion of our 1984 audit, FSLIC

officials have made many of the improvements in their estimation techniques that we had suggested.

Considering better estimation techniques, as well as more current information or asset quality, we found that FSLIC officials had, in 1984, underestimated the probable loss in liquidating the failed institutions' assets. This was the case for all three institutions we expressed concern about in our

1984 opinion. The losses were understated by 21 to 91 percent. For the three institutions taken collectively, FSLIC estimated a loss percentage of 36 cents on the dollar for their 1984

financial statements.

As of December 31, 1985, the loss is

estimated to be 68 cents on the dollar.

While we believe the probable loss on these three

institutions is now fairly presented, there were a number of other institutions which were closed late in 1985. This presents FSLIC and GAO, as its auditors, with a similar

uncertainty which we are working to address.

This year,

however, we may find this issue dwarfed by the concern over the many institutions which have been placed in the management consignment program (MCP) or which are operating with negative GAAP net worth. Let me turn to the MCP cases first.

Management consignment program

The management consignment program was designed to accomplish several objectives. In the case of an insolvent thrift--the program's first application--it removes the directors and management groups responsible for the decisions that led to the failure and averts any further desperate attempts to attain solvency. It attempts to restore public confidence in the institution (which is often the object of attention and speculation in the news media), and enables the institution to stabilize its deposit base. It brings in new management, begins to correct the record keeping (which is often in disarray), and attempts to provide a fair appraisal of the value of the institution's assets. Finally, the institution is

given a new board of directors (selected by the Bank Board) to oversee the management and resolution of problems.

When placing an S&L in the MCP, FSLIC has often provided capital assistance, generally in the form of ICCs, to eliminate the negative net worth. The ICC transaction involves FSLIC purchasing a certificate from the troubled S&L which is repayable, with interest, when the S&L has resumed profitable operations and attained a specified net worth level. In return, FSLIC issues a promissory note to the sick thrift on which it makes interest payments in cash. Both the certificate and note are recorded on FSLIC's books at cost.

FSLIC then establishes

an allowance for possible future loss on the certificate (an asset valuation allowance) to reflect that the value of the asset is impaired.

The MCP cases, of which Beverly Hills is one example, are probably the most troubled group, and others in states with liberal lending practices must be considered further likely candidates for the program.

We are closely examining the potential losses from MCP cases. In 20 of 25 MCP cases during 1985, FSLIC issued $1.5 billion dollars of assistance in the form of ICCs. The other five cases are still being evaluated. Some would argue

that the ultimate cost to FSLIC only begins with this amount. In fact, the total expense to the insurance fund may be much larger. The 25 MCP cases during 1985, had total assets of $17.7 billion and combined negative net worth of $1.6 billion.

On our current audit we are closely analyzing this asset valuation allowance. Our initial feeling is that it does not reflect the true impairment in the value of ICCs purchased from

MCP cases.

Certainly there are numerous arguments to be made either for or against FSLIC's use of the MCP concept to handle the disposition of these problem thrifts over an extended period. To the extent that the program is effective it may be less costly to FSLIC than liquidation would be. In contrast, the potential exists for problems to worsen while the institutions continue to operate, thus resulting in a larger loss to FSLIC. What is not in debate is that the S&Ls in this program are extremely weak and the likelihood of full repayment is remote.

То

Determining the amount of loss to be recognized for these MCP cases is not as simple as some would have you believe. A critical factor is deciding at what point to recognize a loss. Historically, FSLIC has recognized a loss only when an institution is provided financial assistance or is closed. date, FSLIC has recognized no losses related to MCP cases, except for the small valuation allowance on ICCs. Yet, 19 of the 25 S&Ls were in fact closed by their chartering authorities prior to being reopened as federal mutuals by the Bank Board. So while the usual event which triggers recognition of loss--the failure of an S&L--has occurred in most cases, the Bank Board has performed a resurrection which obviates loss recognition.