GAO

United States General Accounting Office

Report to the Chairman, Committee on

Health, Education, Labor, and Pensions,

U.S. Senate

September 2000 HIGHER EDUCATION

Trustee Arrangements

Serve Useful Purpose

in Student Loan

Market

GAO/HEHS-00-170

Page 1 GAO/HEHS-00-170 Student Loan Trustee Arrangements

Contents

Letter 3

Appendixes Appendix I: Scope and Methodology 18

Appendix II: Comments From the Department of Education 20

Appendix III: GAO Contacts and Staff Acknowledgments 21

Related GAO Products 22

Table Table 1: Outstanding Balance of Student Loans Held via Trustee

Arrangements 9

Abbreviations

FFELP Federal Family Education Loan Program

HEA Higher Education Act of 1965

SAP special allowance payments
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Page 3 GAO/HEHS-00-170 Student Loan Trustee Arrangements

United States General Accounting Office

Washington, D.C. 20548

Health, Education, and

Human Services Division

B-284774 Letr

September 25, 2000

The Honorable James M. Jeffords

Chairman, Committee on Health, Education,

Labor, and Pensions

United States Senate

Dear Mr. Chairman:

In fiscal year 1999, approximately $20 billion in loans were made to student

borrowers to help meet their college expenses by lenders participating in

the Federal Family Education Loan Program (FFELP).1 However, because

some of these lenders do not meet the definition of an eligible lender in the

Higher Education Act (HEA) of 1965 and its amendments, they can only

participate in the program via a trustee arrangement with an eligible lender.

In 1998, HEA was amended to include a provision stating that eligible

lenders that serve as trustees are responsible for meeting statutory and

regulatory requirements for the loans they hold as trustees.2

Recently, your Committee raised concerns about the use of trustee

arrangements and whether the trustee requirements under the 1998

amendments to HEA have led to a reduced number of eligible lenders

willing to serve as trustees and to increased costs for ineligible lenders

entering into these arrangements. Because of these concerns and questions

regarding the usefulness of trustee arrangements, you asked us to

determine (1) the number and cost of trustee arrangements and their

shared characteristics, (2) the benefits and protections afforded the federal

government through use of trustee arrangements, and (3) the effect of

trustee arrangements on market participation and the availability of

student loans. In conducting this work, we interviewed a variety of key

participants in the student loan market, including federal officials, eligible

lenders, ineligible lenders, guaranty agencies, and loan servicing

1

FFELP, authorized under the Higher Education Act of 1965, as amended, is one of two

major federal student loan programs and was formerly known as the Guaranteed Student

Loan Program. FFELP provides loans through private lenders, such as banks. These loans

are insured against default by guaranty agencies, which use federal funds to pay claims and

which are reimbursed by Education.

2

This HEA provision codified an existing regulatory requirement promulgated in 1992.
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organizations. We also surveyed eligible and ineligible lenders participating

in trustee arrangements to verify their current status and to determine the

nature of their participation in the student loan program. We conducted our

work between November 1999 and July 2000 in accordance with generally

accepted government auditing standards. (A more detailed discussion of

our scope and methodology appears in app. I.)

Results in Brief The Department of Education reports that approximately 125 trustee

arrangements exist between 16 eligible lender trustees and 31 ineligible

lenders for the purpose of originating or purchasing student loans.3 These

arrangements account for $25.3 billion in outstanding loans—

approximately 19 percent of the outstanding balance of all FFELP loans as

of December 1999. Costs of trustee arrangements fall into two categories—

costs to initiate the arrangement and annual costs to maintain it. According

to the ineligible lenders we interviewed, the costs—which ranged from

$2,500 to $20,000 for initiation fees and from $4,500 to $75,000 for annual

fees—did not prohibit them from conducting business in the student loan

market. The amount charged by an eligible lender for its trustee services

varied and was based on the volume of loans the ineligible lender was

anticipated to originate and on the number and kind of other services the

trustee provided. In addition, both eligible and ineligible lenders reported

little, if any, change in the availability of lenders to serve as trustees or the

costs of these arrangements since 1998. Several characteristics were

common among the trustee arrangements we reviewed, including the

criteria used by trustees to evaluate ineligible lenders before they entered

into trustee arrangements, the various elements of the trustee arrangement

contracts, and the day-to-day interaction between the trustee and the

ineligible lender. For example, most trustees consider the business

reputation of the ineligible lender and the loan servicing organization

chosen by the ineligible lender in deciding whether to enter into an

arrangement.

Trustee arrangements come with some protections to ensure the federal

government’s investment in FFELP is secure while allowing ineligible

lenders to participate in the program. For example, HEA holds eligible

lenders fully responsible for any loans they hold as trustees for ineligible

lenders, including loans that lose the federal guarantee due to problems

3

Trustees and ineligible lenders may be party to one or more arrangements; thus the number

of trustees and the number of ineligible lenders do not add to 125.
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such as lender negligence. Because these problems may not be discovered

until after the government has paid the guaranteed amount, this HEA

provision allows the federal government to recoup any losses from the

eligible lender trustee rather than the ineligible lender. Education officials

believe the government is likely to recover its losses from trustees for two

reasons. First, most financial institutions that serve as eligible lender

trustees are subject to federal (and in many instances, state) oversight. For

example, bank regulators promulgate regulations and policies that

prescribe safe and sound banking activities and examine banks to assess

their safety and soundness. Second, because most eligible lender trustees

also hold student loans in their own name and receive regular FFELPrelated payments from the government for those loans, the federal

government has recourse for recovering any repayments due the

government on ineligible lenders’ loans that lose the federal guarantee.

Education officials stated that because ineligible lenders are generally not

subject to financial safety and soundness reviews by government agencies,

Education lacks assurance that these lenders would be able to meet their

financial obligations in the program.

Both eligible and ineligible lenders said they believe that market

participation and loan availability are positively affected by trustee

arrangements because such arrangements allow lenders that do not meet

HEA’s eligible lender definition to make and hold loans. These lenders said

that the presence of additional lenders in the market increases competition

and thus helps to enhance the products and services lenders offer to

students. However, ineligible lenders said that two factors—HEA

requirements and the general evolution of financial markets—could affect

their continued participation in the future. For example, HEA currently

limits the proportion of student loans certain eligible lenders can hold in

relation to other holdings, and strict application of this provision would

require eligible lenders to include loans held as a trustee in their

calculations. Education officials acknowledged that Education currently

interprets the provision as not including trustee-held loans but has

inconsistently applied this provision in the past, resulting in confusion

among eligible and ineligible lenders as to which lenders can serve as a

trustee. In addition, ineligible lenders reported that the number of available

trustees has decreased as banks have merged with each other in recent

years. We are recommending that Education formally clarify the agency’s

interpretation of the HEA trustee-related provision. In commenting on this

report, Education agreed with this recommendation.
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Background Education administers and oversees federal student aid programs

authorized by HEA, monitors participants’ activities, and establishes

program requirements. Among these financial aid programs is FFELP. The

five principal entities involved in FFELP are students, schools, lenders,

guaranty agencies,4 and Education. At schools participating in FFELP,

students apply to a participating lender for a loan. The school verifies the

student’s eligibility and determines the loan amount the student is eligible

to receive. The student then receives the loan from the lender. The guaranty

agency guarantees the loan against default. The guaranty agency is the

intermediary between Education and the lender, insuring the loan against

default and making certain that the lender and the school meet program

requirements. The lender is responsible for servicing and collecting the

loan, and, if the student defaults on the loan, the lender files a claim with

the guaranty agency for reimbursement of most of its loss.5 Education

reimburses guaranty agencies for most of their claims paid to lenders for

defaulted loans and for some of their administrative costs. Most lenders

contract with a third-party entity to service the loan and collect payments

from borrowers.

HEA designates which entities are eligible to make FFELP loans to

students. In general, an eligible lender is defined as

• under certain circumstances, a national or state chartered bank, a

mutual savings bank, a savings and loan association, a stock savings

bank, or a credit union;

• a pension fund as defined in the Employee Retirement Income Security

Act;

• an insurance company that is subject to examination and supervision by

an agency of the United States or a state;

• in any state, a single agency of the state or a single nonprofit private

agency designated by the state;

4

A guaranty agency is a state or private nonprofit organization that administers a loan

guarantee program under HEA.

5

Guaranty agencies use their federal fund to reimburse lender claims. When a claim for a

defaulted loan is made by a lender to the guaranty agency, regulations require the agency to

pay the lender 98 percent of the loss amount. Education then reimburses the guaranty

agency for up to 95 percent of the loss amount. In certain cases, such as the death or

disability of the student, the reimbursement is 100 percent for both the lender and the

guaranty agency.
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• under certain circumstances, an eligible institution6;

• under certain circumstances, the Student Loan Marketing Association or

the Holding Company of the Student Loan Marketing Association,

including any subsidiary of the Holding Company, or an agency of any

state functioning as a secondary market;

• under certain circumstances, a guaranty agency;

• a Rural Rehabilitation Corporation;

• under certain circumstances, any nonprofit private agency functioning

in any state as a secondary market; and

• a consumer finance company subsidiary of a national bank.

The majority of organizations making loans to students fall into one of

these eligible lender categories. However, organizations that do not meet

HEA criteria may still participate in FFELP by contracting with an eligible

lender to serve as its trustee.7 These ineligible lenders fall into two

categories: (1) secondary markets8 that have not been designated as an

eligible lender for a state and (2) private companies that wish to make and

hold student loans.9

Ineligible lenders generally contract with trustees for three purposes. First,

ineligible lenders contract with trustees to allow the ineligible to originate

student loans or to purchase them from another originating lender. Second,

ineligibles use trustees to securitize portfolios of student loans.10 Third,

trustees are used when ineligibles need to raise the capital necessary to

make or purchase student loans without securitizing other loans. For

example, some secondary markets raise capital by selling tax-exempt

6

An eligible institution is generally an institution of higher education.

7

A trustee is a person or entity, such as a bank, holding legal title to property in order to

administer it for a beneficiary. In the case of student loans, eligible lender trustees hold title

to the loans that ineligible lenders originate or purchase, thus allowing them to participate

in FFELP. As of July 2000, all but one trustee was a bank.

8

Secondary markets are lending institutions that purchase guaranteed student loans from

originating lenders to provide the lenders with funds to make new loans. Twenty of the

approximately 37 secondary markets are designated as eligible lenders and do not need a

trustee to originate or purchase student loans.

9

These entities are referred to in this report as “other ineligible lenders.”

10Portfolios of student loans—originated or purchased by eligible or ineligible lenders—can

be used as collateral to issue securities to investors. The proceeds of these transactions are

then used by the lender to originate new loans to students. This process is known as

securitization.
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bonds to investors. This report is concerned primarily with trustee

arrangements used to enable ineligible lenders to make and hold student

loans.

At FFELP’s outset the government expected to share the program’s

financial risks with state-designated guaranty agencies. However, when

states failed to establish such agencies, the Congress enacted legislation

with several incentives to increase lender and guaranty agency

participation. For example, the Congress provided federal funds for

guaranty agencies to use as seed money to pay claims to lenders. In

providing these incentives, the Congress kept the financial risk almost

entirely with the federal government. The Congress has since shifted some

risk back to the guaranty agencies and lenders by reducing the maximum

reimbursement and insurance rates on defaulted loans. These actions were

intended to encourage both lenders and guaranty agencies to work with

borrowers to prevent them from defaulting on their loans. Apart from the

defaults that occur when borrowers fail to repay their loans, some loans

lose their federal guarantee because lenders, servicers, or guaranty

agencies fail to follow the Department’s requirements for making,

servicing, and collecting loans or because of fraudulent activity at these

organizations. When these latter circumstances occur, Education may

assess penalties, refuse to make future payments, or recover payments

already made to lenders and agencies for such things as interest subsidies

and insurance claims. In 1998, HEA was amended to include a provision

stating that eligible lenders that act as trustees are responsible for meeting

statutory and regulatory requirements for the loans they hold as trustees.

Loss of the federal guarantee due to servicer problems has occurred under

the auspices of trustee arrangements in the past. For example, in the late

1980s, Bank of America served as trustee for the California Student Loan

Finance Corporation—a California secondary market. Education

determined that the loan servicer, United Education and Software

Company, failed to transfer certain information to its new computer system

and then created a computer program that falsely added collection activity

information for a large volume of loans held by the secondary market. As a

result, student loans totaling approximately $400 million lost their federal

guarantee. However, servicer problems that may result in loan guarantee

loss can also occur on loans held by eligible lenders and are not unique to

trustee arrangements.
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Trustee Arrangements

Represent Nearly OneFifth of Outstanding

Loans and Share

Several Characteristics

The Department of Education reports that approximately 125 trustee

arrangements exist between eligible and ineligible lenders. These

arrangements account for $25.3 billion in outstanding loans—

approximately 19 percent of the outstanding balance of all FFELP loans as

of December 1999.11 The 125 arrangements represent liaisons between 16

eligible lender trustees and 31 ineligible lenders. Ineligible lenders can be

further grouped as 17 secondary markets and 14 other ineligibles. Table 1

shows the outstanding balance of loans held via trustee arrangements for

the two categories of ineligible lenders.

Table 1: Outstanding Balance of Student Loans Held via Trustee Arrangements

a

Numbers in parentheses indicate number of lenders in category.

b

As of December 1999 (the most complete information available from Education as of July 2000).

Source: Department of Education FFELP Lender Database.

Costs of trustee arrangements fall into two categories—payments to

initiate the agreement and annual fees to maintain it. The ineligible lenders

we interviewed reported that initiation costs were generally a flat fee

ranging between $2,500 and $20,000. Some of these ineligible lenders, such

as some secondary markets, reported that their trustee (who serves as

trustee for raising capital as well as for originating and purchasing loans)

charged this initiation fee each time they issued bonds to raise capital.

Annual trustee fees reported by ineligible lenders ranged between $4,500

and $75,000, depending on a number of factors. These lenders reported that

the fees could be a flat fee or calculated as a percentage of outstanding loan

balances or on the outstanding balance of bond issues. Ineligible lenders

reported that annual costs are used to maintain the arrangement and cover

the necessary services provided by the trustee, such as transferring

documents between the trustee and the ineligible lender for signature,

11We included outstanding loan balances for originations and purchases, as well as

securitizations of the loans originated or purchased by ineligible lenders. We also included

outstanding loans made under the Student Loan Marketing Corporation’s privatized

operations because a trustee is needed to originate and purchase loans in this circumstance.

Category of ineligible lendera Outstanding loan balanceb

Secondary markets (17) $11.2 billion

Other ineligible lenders (14) $14.1 billion
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handling paperwork associated with the guarantors and servicers involved

in the loan transactions, and carrying out administrative activities

associated with obtaining financing to originate or purchase loans. Some

eligible and ineligible lenders reported that a variety of other factors could

influence the size of both initiation and annual fees. Some of these factors

included

• the structure of the trustee arrangement and the complexity of the

proposed transactions,

• the geographic region in which the trustee and ineligible lender are

located,12

• the trustee’s decision to charge administrative fees on a per-loan basis

rather than as a flat fee,

• the additional services the trustee will perform for the ineligible lender,

such as payroll services, and

• the strength of the trustee’s relationship with the ineligible lender.

Although some ineligible lenders feared that the provision of HEA that

makes trustees fully responsible for trustee-held loans might have an

impact on costs, they reported that costs did not significantly increase or

decrease after the 1998 amendments were enacted and that they did not see

a change in the role of the trustee.13 According to ineligible lenders we

interviewed, current initiation and annual trustee fees do not prohibit them

from conducting business in the student loan market.

The trustee arrangements we reviewed shared several characteristics.

Trustees and ineligible lenders reported similar (1) criteria used by trustees

to evaluate ineligibles before they entered into arrangements, (2) elements

in trustee arrangement contracts, (3) amounts of review performed of

ineligible lenders, and (4) amounts of day-to-day interaction between the

trustee and the ineligible lender. For example, trustees reported that most

important in deciding whether to enter an arrangement is the business

12One eligible lender representative reported that the trustee might charge a lower fee if the

ineligible lender were located in an area where the eligible lender wished to build a market

presence.

13In commenting on this report, Education stated that the 1998 statutory change may not

have had a significant effect because the change merely codified existing regulations.
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reputation of the ineligible lender14 and the reputation of the loan servicing

organization it has chosen. In addition, some trustees review the structure

of the financing method used by the ineligible lender to raise the capital

necessary to originate or purchase loans. This review might include

examining a rating agency’s report on the transaction.15

Trustees and ineligible lenders also reported that their contracts included

similar clauses covering trustee and ineligible lender resignations and

requirements placed on the ineligible lender. For example, they reported

that trustee resignation clauses allow the trustee to resign from the

arrangement by giving a specific number of days’ notice to the ineligible

lender, such as 60 or 90 days. If the ineligible lender is unable to locate

another trustee within that time period, the resignation clause sometimes

provides for additional time to obtain a new trustee. In any event, most

trustees and ineligible lenders reported that the trustee would probably

remain in place until a new one can be engaged, even if the designated time

periods have elapsed. The trustee arrangements we reviewed were also

similar in the requirements placed on the ineligible lender and the amount

of monitoring the trustee performed. For example, trustees generally

require ineligible lenders to abide by HEA requirements and to oversee the

loan servicer, but the trustees perform limited monitoring activities. One

trustee reported that the monitoring is not specific or regular and mostly

involves a review of annual reports and audits. Other trustees reported

limiting their monitoring to a review of financial statements. Eligible lender

trustees and ineligible lenders reported limited day-to-day interaction. For

example, some trustees reported that they interact with the ineligible

lender only when it is necessary to sign forms, such as quarterly reports

that must be submitted to the Department of Education. One trustee

reported no daily interaction.

14Some ineligible lenders served in other roles prior to becoming a lender, such as a guaranty

agency or a servicer.

15Rating agencies assess credit risks on bonds and other financial instruments. Such ratings

help investors, such as those who purchase bonds, to manage their credit risk by providing

risk analysis and evaluation information.
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Trustee Arrangements

Come With Some

Protections for Federal

Investment in Student

Loan Program

Trustee arrangements come with some protections to ensure the federal

government’s investment in FFELP is secure while allowing ineligible

lenders to participate in the program. The most direct protection comes

from an HEA provision that holds eligible lenders fully responsible for any

loans they hold as trustees should the loans lose the federal guarantee. For

example, although Education officials and other FFELP participants

believe the probability of large-scale problems is low, a loan may lose its

guarantee because of servicing errors or because of negligence on the part

of the servicer or the lender. When these problems occur, the federal

government will not reimburse the guarantor or the lender for the

associated dollar loss. However, because some problems may not be found

until after the federal government has already provided reimbursement, the

government may have to recover these monies from the parties involved.

According to Education officials, the HEA provision that holds trustees

responsible for an ineligible lender’s loans allows the federal government to

recoup the losses from the eligible lender trustee rather than the ineligible

lender. Education officials further stated the ability to recoup losses from a

trustee is important since they believe they do not have direct oversight

authority of ineligible lenders. These officials believe the federal

government is likely to recover its losses from trustees for two reasons.

First, most financial institutions that serve as eligible lender trustees are

subject to federal (and in many instances, state) oversight. For example,

bank regulators16 promulgate regulations and policies that prescribe

safeand sound banking activities and examine banks to assess their safety

and soundness. Among the most important of these regulations are those

dealing with minimum capital standards. These capital standards provide

benchmarks against which regulators can assess the safety and soundness

of a bank’s operations as well as its financial condition. Education officials

stated that because ineligible lenders are generally not subject to financial

safety and soundness reviews by government agencies, Education lacks

assurance that these lenders would be able to meet their financial

obligations in the program. Second, because most eligible lender trustees

also hold student loans in their own name and receive regular FFELPrelated payments from the government for those loans, the federal

government has additional sources from which to recover any repayments

16Financial regulators for banks include the Office of the Comptroller of the Currency, the

Federal Reserve System, the Federal Deposit Insurance Corporation, and state banking

regulators.
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due the government on ineligible lenders’ loans that lose their guarantee.

For example, lenders usually receive special allowance payments (SAP)

and interest subsidies17 for the FFELP loans they hold. If the government

were owed monies on an ineligible lender’s loans, it could recover those

funds by withholding the SAP on the eligible lender trustee’s self-originated

loans. Because ineligible lenders do not receive any payments directly from

Education, it does not have an ability to collect liabilities by offset.

Participants Believe

Trustee Arrangements

Positively Affect

Student Loan Market,

Although Some Have

Concerns Over Future

Trustee Availability

Both eligible and ineligible lenders reported that trustee arrangements have

had a positive effect on the student loan market. For example, both

participant groups believe that market participation and loan availability

are positively affected since trustee arrangements allow lenders that do not

meet HEA’s eligible lender definition to make and hold loans, thus

increasing the amount of loan capital available to students. These trustee

arrangements allow ineligible lenders not only to originate loans, but also

to purchase loans that other lenders have originated. This purchasing

role—the primary role for many ineligible secondary markets—permits

originating lenders to free up capital to make new loans to students.

Eligible and ineligible lenders agree that participation by ineligible lenders

increases competition among lenders and can, in turn, contribute to

improved service and lower costs for student borrowers.

Some ineligible lenders, however, believe that two factors—HEA

requirements and the general evolution of financial markets—could affect

their participation in the student loan market in the future. HEA currently

states that a bank functioning as an eligible lender cannot have as its

primary consumer credit function the making or holding of student loans.

Education, in its FFELP regulations, interprets the act to mean that the

lender’s FFELP loans—or in the case of a bank holding company, the

FFELP loans of the company’s wholly owned subsidiaries as a group—

cannot total more than one-half of the lender’s combined consumer credit

loan portfolio, including home mortgages held by the lender or its

subsidiaries. This provision is commonly known as the 50-percent rule.

17Education pays a special allowance to lenders on eligible FFELP loans to bridge the gap

between borrower interest rates set by statute and the interest rate a lender could charge if

the loan funds were used for commercial purposes. The special allowance is a percentage

of the average unpaid principal balance of the loan, including capitalized interest, computed

in accordance with federal regulations. Interest subsidies are interest payments made to

lenders on subsidized loans while the borrower is in school or in deferment.
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Strict application of this rule would require eligible lenders to include loans

they hold as a trustee for an ineligible lender in this calculation, although

the regulations do not specifically address these loans. Education officials

told us that although Education has inconsistently applied the regulations

in the past, it currently interprets the provision as excluding trustee-held

loans in determining the lender’s primary consumer credit function, but has

not formally promulgated its interpretation. Lenders have expressed

confusion regarding application of the rule. For example, some ineligible

lenders and other student loan market participants believe that the 50-

percent rule applies to loans held as a trustee and thus believe that only a

handful of large banks have sufficient consumer credit capacity to serve as

a trustee. Similarly, while a few eligible lender trustee representatives

interpreted the rule as not applying to trustee-held loans, some other

representatives were not sure how the rule should be interpreted. Of those

who were unsure, one trustee representative was not concerned because

either calculation—including or excluding the loans—would place the

bank in compliance with the act. Representatives of one bank incorrectly

interpreted an exception to the 50-percent rule.18 On the other hand, a

representative of another bank stated he had turned down eligible lender

trustee business because the additional trustee-held loans would put the

bank above its 50-percent allocation of student loans.

A second factor that is perceived by ineligible lenders as having the

potential to limit their participation in FFELP is evolution in the financial

markets. Most ineligible lenders we interviewed stated that the number of

available trustees has decreased as eligible lender banks have merged with

each other in recent years. Recent mergers include First National Bank of

Chicago and Bank One, Norwest and Wells Fargo, and Firstar Bank with

Star Bank and Mercantile Bank (St. Louis); financial market analysts

expect this consolidation activity to continue. Four ineligible lenders

reported they had a difficult time obtaining their current trustee

arrangement, one taking over a year to do so. Several others said that

finding a trustee in the future would become more problematic. Ineligible

lender representatives also expressed concern that because trustees also

originate student loans for themselves, trustees may decide to end their

18One exception to the 50-percent rule is “a bank which is subject to examination and

supervision by an agency of the United States, makes student loans as a trustee pursuant to

an express trust, operated as a lender under [the Stafford loan program] prior to January 1,

1975, and which meets the requirements of this provision prior to [July 23, 1992].” 20 U.S.C.

section 1071(d)(1)(A)(ii). An Education official indicated that these criteria apply to only

one specific bank, which is not the bank we interviewed.
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eligible lender trustee services rather than continue to provide the

mechanism for a competitor to do business. A few ineligible lenders stated

they were uncomfortable with trustees having the final say as to which

ineligible lenders can participate in the student loan market. Given these

issues, some ineligible lenders believe their market presence could

diminish in the future.

Conclusions Given current law and the federal regulations that govern FFELP, trustee

arrangements between eligible and ineligible lenders serve an important

role in enabling ineligible lenders to participate in FFELP, and in protecting

the federal government’s investment in the program. The presence of an

eligible lender from whom the government can recoup its financial losses is

critical since Education has no direct oversight authority to ensure that

ineligible lenders are operating their programs in accordance with HEA.

Obtaining a trustee arrangement does not appear to be a widespread

problem among ineligible lenders to date. However, if eligible lenders

remain unclear and therefore continue to interpret the 50-percent rule as

applying to loans they hold as a trustee, and if the financial industry

continues to consolidate, the number of trustees could decline. This

decline could, in turn, reduce competition in the student loan market.

Recommendation for

Executive Action

To clarify eligible lenders’ capacity to serve as trustees for ineligible

lenders, the Secretary of Education should formally clarify Education’s

interpretation of how the HEA provision prohibiting banks or their

subsidiaries from holding FFELP loans that total more than one-half of

their combined consumer credit loan portfolio applies to loans held by the

trustee for an ineligible lender.

Agency Comments Education agreed with our recommendation that it clarify its interpretation

of how the HEA provision applies to loans held by the trustee for an

ineligible lender. Education said that it has not yet decided which policy to

establish nor how to formalize the decision once it is made. Education did

not say when it expected to implement our recommendation. Education

also provided technical comments, which we incorporated where

appropriate. (See app. II for a copy of Education’s comments.)
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We are sending copies of this report to the Honorable Richard Riley,

Secretary of Education; eligible lender trustees; ineligible lenders; and

other interested parties. Copies will also be made available to others on

request.

If you or your staff have any questions about this report, please call me at

(202) 512-7215. Other major contributors to this report are listed in

appendix III.

Sincerely yours,

Barbara D. Bovbjerg

Associate Director, Education, Workforce,

and Income Security Issues
Page 17 GAO/HEHS-00-170 Student Loan Trustee Arrangements
Page 18 GAO/HEHS-00-170 Student Loan Trustee Arrangments

Appendix I

Scope and Methodology ApApenednxidexiIs

We focused our review on trustee arrangements created to allow ineligible

lenders to originate or purchase student loans. To determine the number of

existing trustee arrangements, we obtained data from Education’s lender

database, including the names of the parties involved in each trustee

arrangement, the lender identification number1 associated with each

arrangement, and the outstanding loan balances. These data represent the

best information available, and an Education official acknowledged that

the list might be incomplete. To verify the parties involved in the identified

arrangements and to determine the type of student loan transactions that

made up the outstanding balance associated with a particular lender

identification number, we surveyed eligible and ineligible lenders. For each

lender identification number on the trustee arrangement list, we asked the

lenders to verify whether the account was used for originations and/or

purchases of student loans, securitizations, or some combination of these

transactions. We also asked lenders to provide us with information on any

additional identification numbers used for trustee arrangements. We

conducted follow-up interviews as necessary to ensure that we received

accurate information. In determining the total outstanding balance of loans

associated with trustee arrangements, we included information only for

arrangements that allow ineligible lenders to originate or purchase student

loans and securitizations of these loans. Further, we included balance

information only for the Student Loan Marketing Corporation’s privatized

business and the ineligible lenders it owns, such as Nellie Mae Corporation,

because these organizations must use a trustee to originate or purchase

loans. To obtain detailed information on the identified trustee

arrangements, the costs associated with them, and the key characteristics

they shared, we interviewed Education officials, eligible lender trustee

representatives, and representatives of ineligible secondary markets and

other ineligible lenders. In addition, we conducted joint interviews with

three sets of trustees and ineligible lenders involved in trustee

arrangements and obtained a written response from another. Further, we

obtained information through interviews about the impact of the 1998

amendments to HEA on the number of eligible lenders willing to serve as

trustees and on the costs of trustee arrangements.

1

Education tracks student loan activity primarily via information reported for a specific

lender identification number. Education issues lender identification numbers to each

eligible lender wishing to participate in the student loan program. When a trustee

arrangement is created, Education issues a new number to reflect the loan activity of the

ineligible lender via its trustee.
Appendix I

Scope and Methodology

Page 19 GAO/HEHS-00-170 Student Loan Trustee Arrangments

To determine the protections offered the federal government by trustee

arrangements, we identified and synthesized applicable legislation and

regulations and reviewed sample documents for trustee arrangements. We

also interviewed eligible and ineligible lenders, guaranty agencies,

servicers, Education officials, and other student loan market participants

on the responsibilities of an eligible lender trustee and the process

Education uses to oversee market participants and to recoup any losses it

may incur on defaulted loans.

To determine the effects of trustee arrangements on participation in the

student loan market and the availability of student loans, we interviewed

eligible and ineligible lenders, secondary markets, guaranty agencies,

servicers, Education officials, and other student loan market participants.

We obtained the perspectives of participants on whether trustee

arrangements have a positive or negative effect on lenders’ participation in

the student loan market and identified past, current, and potential

problems lenders faced in using trustee arrangements. Because of the

competitive nature of the student loan market, information obtained from

the lender community was sometimes general in nature. We also obtained

Education officials’ interpretation of applicable laws and their views on the

effects of past rulings regarding trustee arrangements.
Page 20 GAO/HEHS-00-170 Student Loan Trustee Arrangements

Appendix II

Comments From the Department of

Education ApendxiI
Page 21 GAO/HEHS-00-170 Student Loan Trustee Arrangements

Appendix III

GAO Contacts and Staff Acknowledgments ApendxiI

GAO Contacts Barbara D. Bovbjerg, Associate Director, (202) 512-7215

Diana M. Pietrowiak, Assistant Director, (202) 512-6239

Staff

Acknowledgments

Patricia Bundy, Evaluator

George Bogart, Senior Attorney
Page 22 GAO/HEHS-00-170 Student Loan Trustee Arrangements

Related GAO Products

Major Management Challenges and Program Risks: Department of

Education (GAO/OCG-99-5, Jan. 1999).

Risk-Based Capital: Regulatory and Industry Approaches to Capital and

Risk (GAO/GGD-98-153, July 20, 1998).

High-Risk Series: Student Financial Aid (GAO/HR-97-11, Feb. 1997).

Student Loan Lenders: Information on the Activities of the First

Independent Trust Company (GAO/HRD-90-183FS, Sept. 25, 1990).

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