Valuing Federal Disaster Loans for Investment

Abstract

MARK POTTER is an assistant professor of finance at Babson College in Babson Park, Massachusetts. T he Small Business AdministraŽ . tion SBA makes loans to owners of businesses and residences damaged in formally declared disasters, such as floods or hurricanes. Although these loans are now held within the SBA, the President’s 1999 budget submission proposes that SBA loans be sold to private investors. Anticipating new markets for these types of loans, this article takes a fresh look at government loan valuation. Using data on over 130,000 flood and hurricane disaster loans disbursed between 1980 and 1990, we estimate loan write-offs and early repayments using a discrete proportional hazards model. Then, using a stochastic interest rate model, we simulate loan termination probabilities to calculate the expected present value of the loans’ cash flows. Our analysis indicates an implied subsidy rate in the neighborhood of 26% for the 1990 loan cohort. Adding administrative costs and transactions fees to this rate defines the ‘‘true’’ cost to the government and, therefore, to private investors, of this particular disaster loan program. In the following section, the SBA’s Disaster Loan Program and related research in mortgage loan valuation is discussed. The data and methodology, including details of the valuation of disaster loans, are then presented. Empirical results as well as loan valuation simulations follow. We conclude with a discussion of the implications of our results for potential investors to these and other similar U.S. government loan programs.