Methodology to Identify Loans Eligible for 9.5 Percent SAP

DCL FP-07-06

April 27, 2007

The following provides a brief summary of the basis for the Department's
methodology and procedures, as included in the Auditor's Guide that was
developed by the Department's Office of the Inspector General (OIG), to
ensure the accuracy of special allowance payment (SAP) billings at the
9.5 percent minimum return rate. See Dear Colleague Letters FP-06-15, FP
07-01 and FP-07-06.

# Objectives of the Methodology

The methodology to identify loans eligible for SAP at the 9.5 percent
minimum return rate was designed by the Department to be relatively
uncomplicated, easy to implement, and to apply uniformly both to lenders
that make loans and to lenders that acquire loans in the secondary
market. The methodology draws inferences regarding loan eligibility from
data that are readily available to the lender and is designed to
identify those loans that are currently eligible for the 9.5 percent SAP
rate sufficient for purposes of the comprehensive resolution offered in
a letter, dated January 24, 2007, that was sent to any lender that was
claiming, at that time, SAP at the 9.5 percent minimum return rate.

[Data Required for Implementation of the Methodology]{.underline}

To achieve the objectives of the 9.5 percent minimum SAP audit, the
methodology requires examination of readily retrievable data from
records routinely created by lenders for each loan on which the lender
is claiming SAP at the 9.5 percent minimum return rate. This includes
data about the tax-exempt bond or other eligible source that funded the
loan and about each loan.

For the tax-exempt bond, the data required includes the date of issue of
the bond on which the eligibility of the loan for SAP at the 9.5 percent
rate depends, and the amount of the bond. The bond on which eligibility
of the loan depends refers to that tax-exempt obligation, the proceeds
of which were used either to make or acquire the loan or to make or
acquire a loan (first generation loan) that generated funds used to make
or acquire the loan in question (second generation loan). Only
tax-exempt bonds originally issued prior to October 1, 1993 or a
tax-exempt obligation that refunds such an original obligation can
support eligibility.

For each loan for which the lender currently claims SAP at the 9.5
percent rate, the methodology requires only a limited set of data,
including the date of the transaction when the lender made or acquired
the loan and the amount spent by the lender to make or acquire the loan.
In some instances, the loan may be one that the lender initially made or
acquired using sources other than those from a pre-October 1, 1993
tax-exempt obligation. For such a loan, the transaction in question is
the one by which the lender refinanced the loan using funds from an
eligible tax-exempt source, and then began treating the loan as one that
qualifies for the 9.5 percent SAP rate. Whether or not the lender has
created or retained records of the particular source of funds used to
acquire the loan, the lender is reasonably expected to have billed for
SAP on the loan at all times, and to have recorded the date on which it
first characterized the loan as billable for SAP at the 9.5 percent
rate. The methodology focuses on that date as the date on which the
lender "acquired" the loan for its tax-exempt portfolio.

Methodology to Identify Loans Eligible for 9.5 Percent SAP

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# Assumptions Used in the Methodology

The audit methodology applies several assumptions, based on Department
experience and pertinent legal requirements, about the use of bond
proceeds and the characteristics of loans. The methodology considers the
FFELP loans for which 9.5 percent minimum SAP is being billed to have
the same average lifespan as other FFELP loans, which the Department has
determined to be 19 years for consolidation loans and 8.5 years for
other FFELP loans.[^1] The methodology also assumes that the lender
spent the original proceeds of the eligible bond to make or acquire
loans within the three-year period expected under applicable rules that
apply to using the proceeds of a tax-exempt obligation. Loans are
assumed to have been amortized in a straight-line manner over this
19-year or 8.5-year lifespan. Finally, repayments, as well as interest
and SAP received on first-generation loans are assumed to have been
promptly used to make or acquire second-generation loans.

The assumptions, noted above, may offset any disadvantage that might
otherwise be imposed on a lender whose practices and loan
characteristics differed from those assumptions. First, the methodology
initially assumes that each of the loans made or acquired within three
years of the bond issuance date is an eligible, first-generation loan,
and that each of the loans acquired within the subsequent period (19
years or 8.5 years, as applicable) is an eligible, second-generation
loan. Of course, the methodology limits this assumption -- for both
generations of loans -- to the extent that the amount of the funds
expended to make or acquire the loans can not exceed the amount that
would have been available either as bond proceeds or as repayments,
interest, and SAP on first-generation loans.

Second, the methodology assumes that all proceeds of the eligible bond
were used to acquire first-generation loans. In reality, the costs of
issuance would have consumed some bond proceeds.

Third, the methodology assumes that the lender used all repayments and
interest and special allowance payments received on first-generation
loans to make or acquire eligible, second-generation loans.

Fourth, the methodology treats any loan made or acquired within a full
period of 22 years (Consolidation) or 11.5 years (Stafford/PLUS) from
the issuance of the bond to be a potentially eligible second-generation
loan.

Methodology to Identify Loans Eligible for 9.5 Percent SAP

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# Limits on Use of the Audit Results

Demonstrating the eligibility of pending and future 9.5 percent SAP
claims under the prescribed audit methodology is an essential condition
in the comprehensive resolution offered in a letter, dated January 24,
2007, that was sent to any lender that was claiming, at that time, SAP
at the 9.5 percent minimum return rate. The Department agrees to accept
the results of the audit as sufficient proof of current and prospective
eligibility under the conditions stated and for the purpose of resolving
disputes regarding eligibility. In agreeing to this method of
demonstrating eligibility of loans that were included in a lender's
December 31, 2006 billing for SAP at the 9.5 percent minimum rate, the
Department is not waiving the legal requirements, as restated in DCL
FP-07-01, for a loan to be eligible to receive SAP at the 9.5 percent
minimum rate. The Department simply agrees to the manner in which a
lender that accepts this offer of comprehensive resolution can prove
that its loans met those requirements. In any other context, proof of
eligibility remains the obligation of the lender.

Finally, this audit process examines only whether a loan billed at the
9.5 percent SAP rate is considered to be eligible now and in the future
as a first-generation or second-generation loan. However, under
applicable law, an eligible loan loses eligibility for SAP at the 9.5
percent rate if any of a number of transactions or events occurs. This
audit is not designed to examine whether the eligibility of a loan for
9.5 percent SAP has lapsed. A determination that a particular loan is an
eligible first-generation or second-generation loan is not a
determination that the loan retained eligibility for SAP at the 9.5
percent rate, or that the loan met other applicable legal requirements
for receiving SAP.

[^1]: The Department makes this determination as part of its obligation
    under the Federal Credit Reform Act of 1990, 2 U.S.C. § 661 et seq.,
    to calculate the subsidy cost for FFELP loans.