GAO

United States General Accounting Office

Report to Congressional Requesters

January 2001 DEPARTMENT OF 

EDUCATION

Key Aspects of the 

Federal Direct Loan 

Program’s Cost 

Estimates

GAO-01-197

Page 1 GAO-01-197 FDLP Cost Estimates

Contents

Letter 3

Appendixes Appendix I: Estimating Credit Program Costs 48

Appendix II: Objectives, Scope, and Methodology 54

Appendix III: GAO Contacts and Staff Acknowledgments 59

Glossary 60

Tables Table 1: Amounts Borrowed From Treasury to Finance FDLP 11

Table 2: Appropriations Received to Finance FDLP 13

Table 3: Cash Inflows and Outflows by Fiscal Year 14

Table 4: Percentage Impact of Changes in Key Assumptions 

on Subsidy Costs by Loan Profile 19

Table 5: GAO Estimates of Dollar Impact of Changes in Key 

Assumptions on Subsidy Costs by Loan Profile 20

Table 6: Summary of Key Assumptions and Sources of Data 21

Table 7: Total Estimated and Actual Key Cash Flows for Fiscal 

Years 1995 Through 1999 25

Table 8: Effect of Fee Reduction on Subsidy Costs 32

Table 9: Comparative Direct Loan Program Estimates, Per 

$100 of Loans 41

Table 10: Primary Types of Data Used in Education's 1999 

Cost Study 42

Figures Figure 1: Estimated and Actual Interest Receipts 26

Figure 2: Estimated and Actual Principal Receipts 27

Figure 3: Estimated and Actual Origination Fees 28

Figure 4: Estimated and Actual Collections on Defaults 29

Figure 5: FDLP Borrower Rates and Discount Rates 36

Figure 6: Historical 91-Day Treasury Bill Rates 38
Contents

Page 2 GAO-01-197 FDLP Cost Estimates

Abbreviations

FASAB Federal Accounting Standards Advisory Board

FCRA Federal Credit Reform Act of 1990

FDLP Federal Direct Loan Program

FFELP Federal Family Education Loan Program

NSLDS National Student Loan Data System

OMB Office of Management and Budget

OSFA Office of Student Financial Assistance

SFFAS Statement of Federal Financial Accounting Standards
Page 3 GAO-01-197 FDLP Cost Estimates

United States General Accounting Office

Washington, D.C. 20548 Letr

January 12, 2001

The Honorable Jim Nussle 

Chairman, Committee on the Budget

House of Representatives

The Honorable Judy Biggert

House of Representatives

The Department of Education administers two major federal student loan 

programs, the William D. Ford Federal Direct Loan Program (FDLP) and 

the Federal Family Education Loan Program (FFELP). The federal 

government’s role differs significantly between these two programs. Under 

FDLP, often referred to as the direct loan program, students or their 

parents borrow money directly from the federal government through the 

schools the students attend, which include vocational, undergraduate, or 

graduate schools. The first FDLP loans were made in the fourth quarter of 

fiscal year 1994. Under FFELP, also known as the guaranteed student loan 

program, money is borrowed from private lenders, such as banks, and the 

federal government guarantees repayment if the borrowers default. FFELP 

is the older of the two programs, having started in fiscal year 1966. As of 

September 30, 1999, Education reported that the outstanding gross balance 

of FDLP was $46.5 billion and the total outstanding loan guarantees for 

FFELP were approximately $127 billion. As of September 30, 1999, 

Education estimated that it would incur total subsidy costs—the estimated 

cost of extending credit over the life of the loans—of $1.6 billion for FDLP 

and $12.2 billion for FFELP.

FDLP, established by P.L. 103-66, was implemented by Education in fiscal 

year 1994 as another method of delivering loans to students. FDLP makes it 

possible for students and their families to borrow directly from the federal 

government through the colleges or other postsecondary institutions the 

students attend. In fiscal year 1999, 3.2 million loans totaling $17.7 billion 

were disbursed to borrowers through FDLP. 

Because of concerns about Education’s reliance on estimates to project 

FDLP costs and a lack of historical information on which to base those 

estimates, you asked us to review how Education develops its cost 

estimates for the program, review and analyze actual versus estimated 

financial performance, and address factors or circumstances that can 

significantly affect Education’s ability to develop realistic estimates of 

program costs. Specifically you asked us to address nine questions.
Page 4 GAO-01-197 FDLP Cost Estimates

1. How much financing has been provided to Education for the direct loan 

program through borrowing from Treasury and appropriations 

received?

2. Have cash inflows (excluding borrowings from Treasury and borrower 

principal repayments) exceeded cash outflows (excluding repayments 

to Treasury and loan disbursements)?

3. In Education’s calculation of its subsidy cost estimates for the Federal 

Direct Loan Program, what are the key cash flow assumptions, how 

sensitive are Education’s subsidy costs to changes in these 

assumptions, and what data are used to support these assumptions?

4. How closely do Education’s subsidy cost estimates and their underlying 

assumptions compare to actual loan performance for each loan and to 

what extent does Education track differences between its subsidy cost 

estimates and actual loan performance for each loan cohort?

5. What effects have reduced loan origination fees had on subsidy costs, 

and how has Education taken account of these changes in its subsidy 

cost estimates and reestimates?

6. What effects have increased consolidations had on subsidy costs, and 

how has Education taken account of these changes in its subsidy cost 

estimates and reestimates?

7. What effect have declining interest rates had on subsidy costs, and how 

has Education taken account of these changes in its subsidy cost 

estimates and reestimates?

8. What are the future prospects for the continued negative subsidy for 

the Federal Direct Loan Program?

9. What data did Education use to project an estimated savings of $4 for 

every $100 of direct student loans, as it reported in November 1999?
Page 5 GAO-01-197 FDLP Cost Estimates

To respond to your request, we reviewed Education’s audited financial 

statements and examined the workpapers of Education’s independent 

auditors for fiscal years 1995 through 1999. We interviewed knowledgeable 

personnel from Education’s Budget Service and obtained information 

relevant to your questions. We compared Education’s practices to 

(1) federal budgeting and accounting standards—such as Statement of 

Federal Financial Accounting Standards (SFFAS) No. 2, Accounting for 

Direct Loans and Loan Guarantees, as amended, and Office of Management 

and Budget (OMB) Circular A-11, Preparation and Submission of Budget 

Estimates—and (2) the guidance contained in the Federal Financial 

Accounting and Auditing Technical Release 3, Preparing and Auditing 

Direct Loan and Loan Guarantee Subsidies Under the Federal Credit 

Reform Act.

1

 Our audit work was conducted in Washington, D.C., from May 

2000 through November 2000 in accordance with generally accepted 

government auditing standards. Appendix II describes our objectives, 

scope, and methodology in detail. We provided the Department of 

Education copies of a draft of this report for review and comment. On 

December 7, 2000, we met with cognizant Education officials and obtained 

oral comments on a draft of this report.

Because of the number and diverse nature of the questions, we are 

responding in a question-and-answer format. The next section provides an 

overview of some of the key points from our review.

Overview Several circumstances make it difficult to make the best possible 

determination of FDLP’s financial performance at this time. First, because 

FDLP is a relatively new program, it has a short history of repayment 

activity and little historical data are available. Second, because Education 

lacks historical FDLP data, Education relies heavily on data from the 

guaranteed loan program to develop estimates for most key cash flow 

assumptions in its FDLP cash flow model, which is used to estimate the 

subsidy cost of the program. While this is appropriate for the interim, 

1

The Credit Reform Task Force of the Accounting and Auditing Policy Committee was 

formed in order to address key issues surrounding the implementation of the Federal Credit 

Reform Act of 1990 and the related federal accounting standard. This task force developed 

Technical Release 3, which is expected to be formally issued by OMB during fiscal year 

2001. The purpose of Technical Release 3 is to provide implementation guidance for 

agencies and auditors to prepare, utilize, and report on credit subsidy estimates. Technical 

Release 3 does not take precedence over existing accounting standards and budget 

guidance.
Page 6 GAO-01-197 FDLP Cost Estimates

guaranteed loans may perform differently from FDLP loans and therefore, 

Education ultimately will need to use FDLP data. Education plans to phase 

out the use of guaranteed loan data as FDLP data become available. 

Our ability to answer some of your specific questions was limited because 

the needed data were not readily available. For example, Education’s cash 

flow model and financial systems do not readily provide comparable 

information on estimated and actual defaults. Also, Education did not have 

readily available performance data by “cohort,” which refers to all the loans 

of a particular loan type for which a subsidy appropriation is provided for a 

given fiscal year. For this reason, Education was not able to give us a 

comparison of estimated to actual cash flows at the cohort level during the 

time frames of this review. Comparisons of estimates and actuals at the 

cohort level are key to identifying the causes of disparities, which, in turn, 

is key to improving future subsidy cost estimates. Furthermore, there is 

little information on the effects of loan consolidations on FDLP subsidy 

costs. This is significant because Consolidation loan volume has been 

rapidly increasing. Education is taking or plans to take steps to address 

these limitations in the future. 

Because Education has not documented its previous sensitivity analyses, 

we asked Education to perform a limited sensitivity analysis2

 of FDLP 

subsidy costs and found that the subsidy calculation is most sensitive to 

changes in interest rates. Specifically, the interest rates involved were the 

discount rate—generally the rate at which Education borrows money from 

the Department of the Treasury to finance its loans—and the borrower 

rate. The difference, or spread, between the borrower rate and discount 

rate determines the magnitude the change in interest rates has on the FDLP 

subsidy cost. Because these rates cannot be readily predicted from year to 

year, estimating the subsidy cost of FDLP is very difficult. Therefore, wide 

fluctuations in subsidy costs can be expected depending on the extent of 

interest rate changes. 

Because FDLP is a direct loan program that allows its borrowers to defer 

payment until after the borrower leaves school, several years would 

typically pass between the time the borrower receives the loan and begins 

making repayments. This deferment of principal and interest payments 

from borrowers has contributed to the negative cash flow FDLP 

2

Sensitivity analysis is a process used to identify which cash flow assumptions, when 

adjusted, have the greatest impact on the estimated subsidy costs.
Page 7 GAO-01-197 FDLP Cost Estimates

experienced that totaled about $2 billion as of September 30, 1999. 

Although more cash will be received by Education when more borrowers 

enter repayment, Education is unable to determine when FDLP will have a 

positive cash flow primarily because of uncertainty related to the key cash 

flow assumptions. Further, because Education lacks key data on loan 

consolidations and default data is not readily available, Education’s ability 

to predict future cash flows is limited. This further impedes Education’s 

ability to estimate when and how much of this negative cash flow will be 

recovered.

We are making several recommendations to address the limitations 

identified during our review.

Background Education is the primary agency overseeing federal investments in support 

of educational programs for U.S. citizens and eligible noncitizens. In fiscal 

year 1999, more than 8.1 million students received over $53 billion in 

federal student financial aid, including loans and grants, through programs 

administered by Education.

FDLP offers four different loan types.

• The Federal Direct Stafford Subsidized/Ford Loan Program (Stafford 

Subsidized), available only to students with a demonstrated financial 

need, provides loans to undergraduate, graduate, and professional 

students. Interest is subsidized by the federal government while the 

student is in school, and during the grace,3

 or deferment4 period. A loan 

origination fee is charged to obtain these loans. The borrower rate is 

variable and based on the 91-day Treasury bill rate plus an add-on 

amount that has ranged from 1.7 percent to 3.1 percent, with a 

maximum borrower rate of 8.25 percent. Education reported that the 

outstanding balance of this loan type was $19.7 billion as of 

September 30, 1999.

3

A grace period is a 6-month period that begins on the day after a FDLP borrower ceases to 

be enrolled as at least a half-time student at an eligible institution and ends on the day 

before the repayment period begins.

4

Deferment periods are periods during which the payment of the principal is postponed. 

Reasons for deferment include in school status, unemployment, and economic hardship.
Page 8 GAO-01-197 FDLP Cost Estimates

• The Federal Direct Unsubsidized Stafford/Ford Loan Program (Stafford 

Unsubsidized) provides loans to undergraduate, graduate, and 

professional students regardless of financial need. The borrower is 

responsible for interest that accrues during any period. Interest that 

accrues while the student is in school or during the grace period or 

deferment period is added to the loan balance. A loan origination fee is 

charged to obtain these loans. The borrower rates on these loans are the 

same as the borrower rates on Stafford Subsidized loans. Education 

reported that the outstanding balance of this loan type was $11.9 billion 

as of September 30, 1999.

• The Federal Direct PLUS Program provides loans to parents of 

dependent students. The borrower is responsible for interest that 

accrues during any period. A loan origination fee is charged to obtain 

these loans. The borrower rate is variable and currently based on the 

91-day Treasury bill rate plus an add-on amount of 3.1 percent, with a 

maximum borrower rate of 9 percent. Education reported that the 

outstanding balance of this loan type was $2.8 billion as of 

September 30, 1999.

• The Federal Direct Consolidation Loan Program (Consolidation loans) 

allows borrowers to combine their loans from different federal student 

loan programs into a single loan with one monthly payment.5

 After the 

promissory note has been signed for the new Consolidation loan, the 

underlying loan(s) are paid off. The Higher Education Act Amendments 

of 1998 (P.L. 105-244) provided that for all Direct Consolidation Loan 

applications received from February 1, 1999, through June 30, 2003, the 

borrower rate is a fixed rate for the life of the loan. The rate is the lesser 

of the weighted average of the interest rates on the loans being 

consolidated, or 8.25 percent, the current maximum allowable rate. 

Borrower rates on previously disbursed Consolidation loans are 

variable rates, similar to the other FDLP loan types. Education reported 

that the outstanding balance of this loan type was $12.1 billion as of 

September 30, 1999.

5

Some of the federal student loans that are permitted in an FDLP consolidation include 

FDLP, FFELP, and Perkins loans as well as health professional loans, such as Health 

Education Assistance and Nursing Student loans.
Page 9 GAO-01-197 FDLP Cost Estimates

Borrowers most commonly repay their FDLP loans using one of four 

repayment plans: standard, extended, graduated, or income contingent.6

These four options differ by the amount of time allowed to repay loans and 

the flexibility of the repayment schedule. With standard repayment, 

borrowers make fixed payments of at least $50 a month for up to 10 years. 

With extended repayment, they make fixed payments of at least $50 a 

month over a period generally ranging from 12 to 30 years, depending on 

the total amount borrowed. With graduated repayment, borrowers’ 

payments start out low and then increase, usually every 2 years; the 

repayment period generally ranges from 12 to 30 years, depending on the 

total amount borrowed. The income contingent repayment plan is the most 

flexible, allowing borrowers to make monthly payments that are based on 

adjusted gross income, family size, and the total amount of their 

outstanding loans. 

The Federal Credit Reform Act of 1990 (FCRA) was enacted to require 

agencies to more accurately measure the government’s cost of federal loan 

programs and to permit better cost comparisons both among credit 

programs and between credit and noncredit programs. Prior to the 

implementation of FCRA, credit programs were reported in the budget on a 

cash basis. Thus, loan guarantees appeared to be free in the budget year, 

while direct loans appeared to be as expensive as grants. As a result, costs 

were distorted and credit programs could not be compared meaningfully 

with other programs and with each other. FCRA and the related accounting 

standards and budgetary guidance, together known as credit reform, were 

established to more accurately measure the government’s costs of federal 

credit programs and to permit better comparisons both among credit 

programs and between credit and noncredit programs. As part of 

implementing credit reform, agencies are required to estimate the net cost 

of extending credit over the life of a loan, generally referred to as the 

subsidy cost, based on the present value7

 of estimated net cash flows, 

excluding administrative costs.

6

A fifth type of repayment plan that is rarely used−alternative repayment−is also available to 

FDLP borrowers. Also, the income contingent repayment plan is not available to borrowers 

of PLUS or Consolidation PLUS loans.

7

Present value is the worth of the future stream of returns or costs in terms of money paid 

immediately. In calculating present value, prevailing interest rates provide the basis for 

converting future amounts into their “money now” equivalents.
Page 10 GAO-01-197 FDLP Cost Estimates

Budgeting guidance requires agencies to maintain supporting 

documentation for subsidy cost estimates. Further, auditing standards 

related to estimates indicate that agency management is responsible for 

accumulating sufficient relevant and reliable data on which to base the 

estimated cash flows. SFFAS No. 2 states that each credit program should 

use a systematic methodology to project expected cash flows into the 

future. To accomplish this task, agencies develop cash flow models. A cash 

flow model is a computer program that generally uses historical 

information and various assumptions including defaults, prepayments, 

recoveries, and the timing of these events to estimate future loan 

performance. Those assumptions that have the greatest impact on the 

estimated subsidy cost are often referred to as the key assumptions. These 

cash flow models, which should be based on sound economic, financial, 

and statistical theory, identify key factors that affect loan performance. 

Agencies use this information to make more informed predictions of future 

credit performance. Generally, the data used for these estimates are 

updated or reestimated after the fiscal year end to reflect any changes in 

actual loan performance since the estimates were prepared, as well as any 

expected changes in assumptions related to future loan performance. 

Appendix I provides a detailed discussion of estimating credit program 

costs under credit reform. The glossary at the end of this report provides a 

list of commonly used terms related to credit program budgeting and 

accounting.

Questions and Answers

Question 1 How much financing has been provided to Education for the direct loan 

program through borrowing from Treasury and appropriations received?

Amounts borrowed from Treasury are amounts that Education expects to 

be repaid by borrowers in the future. Amounts appropriated are amounts 

that Education has estimated it will lose as a cost of extending credit 

through FDLP. For fiscal years 1995 through 1999, Education’s FDLP has 

borrowed $59.4 billion from Treasury to finance the program, repaying 

$7.8 billion of that amount. Table 1 provides an annual accounting of this 

information. Over the same period, considering reestimates, Education has 

received $688 million in appropriations (see table 2). 
Page 11 GAO-01-197 FDLP Cost Estimates

Table 1: Amounts Borrowed From Treasury to Finance FDLP

Source: Department of Education.

Education finances FDLP through a combination of appropriations and 

borrowing from Treasury as required by FCRA. For loan programs subject 

to the act, agencies are required to estimate the cost of extending or 

guaranteeing credit, called the subsidy cost. The subsidy cost is the present 

value of disbursements from the government (loan disbursements and 

other payments) minus estimated payments to the government 

(repayments of principal, interest receipts, fees, and other recoveries or 

payments) over the life of the loan. The subsidy cost is generally the 

amount that Education estimates will not be repaid by borrowers. This 

estimate is financed with appropriated funds and is generally “reestimated” 

or updated annually. The portion of Education’s direct loans that Education 

predicts will ultimately be repaid by borrowers is financed by borrowing 

from Treasury and is not considered a cost to the government because it is 

expected to be returned to the government in future years. If the present 

value of the estimated cash outflows from the government exceeds the 

present value of the estimated cash inflows, there is a positive subsidy or 

cost to the government. However, if the present value of the estimated cash 

inflows to the government exceeds the present value of the estimated cash 

outflows, there is a negative subsidy.

(Dollars in millions)

Fiscal year

Opening

balance

Borrowings

from Treasury

Repayments to

Treasury

Outstanding

balance at yearend

1995 $433 $4,868 $235 $5,067

1996 5,067 7,957 669 12,355

1997 12,355 11,333 975 22,713

1998 22,713 13,669 1,284 35,098

1999 35,098 21,571 4,599 52,070

Total $59,398 $7,762
Page 12 GAO-01-197 FDLP Cost Estimates

When there is a negative subsidy, a higher level of borrowing from Treasury 

occurs than when there is a positive subsidy because Education must 

borrow an amount greater than the dollar amount of loans disbursed. This 

additional borrowing occurs because Education does not receive any 

appropriated funds and therefore experiences a temporary shortfall 

because, in addition to disbursing the full loan amount, Education pays the 

negative subsidy to its program account.8

 This additional amount of 

borrowing as well as the amount of loans disbursed is expected to be 

repaid by the borrower, primarily through principal and interest payments, 

over the life of the loan. 

For example, if a hypothetical FDLP loan of $100 had a negative subsidy of 

$5, the amount of borrowing required would be $5 more than the face value 

of the loan. Accordingly, Education would borrow a total of $105 from 

Treasury. If, however, FDLP had a positive subsidy, required borrowing 

from Treasury would be less. For example, if a hypothetical FDLP loan of 

$100 had a positive subsidy cost of $5, the subsidy cost of $5 would be 

financed with appropriated funds, and the remaining $95 would be 

financed by Treasury borrowings (the amount Education expects to be 

repaid).

Additionally, Education is required to periodically update or “reestimate” 

loan program costs for differences between (1) estimated loan 

performance and related cost and (2) the actual program costs recorded in 

the accounting records as well as expected changes in future economic 

performance. When program costs are reestimated for loans disbursed in 

prior years, the revised estimate can either increase or decrease the 

original subsidy estimate. These reestimates can also affect the level of 

borrowing and appropriations. Generally, downward reestimates are 

considered offsetting receipts, which are netted against the subsequent 

year’s appropriations, and upward reestimates require additional 

appropriations.9

8

For mandatory programs such as FDLP, amounts from negative subsidies and downward 

reestimates may be credited directly to the program account, which is a budget account that 

receives appropriations to cover the subsidy cost of a direct loan or loan guarantee and 

disburses the subsidy cost to the financing account. The financing account is explained in 

the glossary at the end of this report.

9

A permanent indefinite appropriation is available for upward reestimates.
Page 13 GAO-01-197 FDLP Cost Estimates

Table 2 shows FDLP’s original subsidy estimates and reestimates for the 

1995 through 1999 cohorts. For example, the 1997 cohort column in table 2 

shows that this group of loans was originally estimated to have a positive 

subsidy of $336 million. Since then, Education has reestimated the cost of 

the 1997 cohort twice, increasing its cost by $80 million in fiscal year 1998 

and decreasing its cost by $69 million in fiscal year 1999. Therefore, as of 

fiscal year 1999, the estimated net cost of the 1997 cohort was a positive 

subsidy of $347 million. In contrast, the fiscal year 1999 column shows that 

the 1999 cohort was the first cohort originally estimated to have a negative 

subsidy. For fiscal years 1995 through 1999, Education’s FDLP estimates 

and reestimates for all cohorts show a total positive subsidy of 

$688 million, and therefore Education has received net appropriations 

totaling this amount.

Table 2: Appropriations Received to Finance FDLP 

Note: The figures for reestimates indicate the amount of increase or decrease to the original subsidy 

estimate. 

Source: Department of Education.

Because FDLP is a relatively new program, there is limited historical data 

to predict future borrower behavior. Additionally, the future estimated cost 

of this program, as explained in questions 3 and 7, is especially sensitive to 

changes in interest rates. Therefore, fluctuations such as those shown in 

table 2 are not unexpected and are likely to continue in the future.

Question 2 Have cash inflows (excluding borrowings from Treasury and borrower 

principal repayments) exceeded cash outflows (excluding repayments to 

Treasury and loan disbursements)?

(Dollars in millions)

Cohort

1995 1996 1997 1998 1999 Total

Original subsidy 

estimate

$490 $237 $336 $213 $(378) $898

Reestimate 1 (6) 128 80 (129)

Reestimate 2 (157) 153 (69)

Reestimate 3 (58) (71)

Reestimate 4 (81)

Net appropriations $188 $447 $347 $84 $(378) $688
Page 14 GAO-01-197 FDLP Cost Estimates

Loan origination fees and interest receipts from borrowers are the primary 

sources of cash inflows for FDLP. Net interest payments to Treasury on 

borrowed funds to finance the loans disbursed are the primary source of 

cash outflows.10 As shown in table 3, for fiscal years 1995 through 1999, 

total cash outflows exceeded total cash inflows by about $2 billion because 

the interest receipts from borrowers and origination fees were less than the 

amount of interest Education had to pay to Treasury. Inflows exceeded 

outflows only in fiscal years 1995 and 1996. 

Table 3: Cash Inflows and Outflows by Fiscal Year

Source: Department of Education.

The $2 billion negative cash flow for FDLP is at least partially due to a 

timing difference in the cash flows. Education is required to make interest 

payments to Treasury, even if the borrower is not currently making interest 

payments to Education. As of September 30, 1999, 46 percent of the loan 

portfolio was in a grace or deferment status. As a result, Education 

subsidizes or generally accrues this interest. However, Education must 

repay the interest on borrowings from Treasury even though it does not 

expect to receive interest payments from borrowers until sometime in the 

future. This accrued interest can be substantial—$2.3 billion as of 

September 30, 1999.

Education is unable to determine when FDLP will have a positive cash flow 

primarily because of uncertainty related to the key cash flow assumptions. 

As discussed in question 3, the estimated cost of FDLP is sensitive to 

changes in interest rates and other factors that will affect the program’s 

cash flows. In addition, reductions in origination fees, as occurred in fiscal 

10Cash inflows and outflows discussed in this answer are defined as stated in the question.

(Dollars in millions)

Description 1995 1996 1997 1998 1999 Total

Loan origination fees $85 $318 $352 $382 $387 $1,524

Interest receipts from 

borrowers 

14 113 300 606 1,067

2,100

Net interest payment on 

Treasury borrowings

(86) (348) (1,180) (1,686) (2,395)

(5,695)

Net cash inflows/(outflows) $13 $83 $(528) $(698) $(941) $(2,071)
Page 15 GAO-01-197 FDLP Cost Estimates

year 1999, discussed in question 5, will also have an impact on whether 

FDLP has an overall negative or positive cash flow in the future. Further, 

cash flows for FDLP can be affected by changes in macroeconomic 

conditions, such as unemployment rates and inflation. 

Question 3 In Education’s calculation of its subsidy cost estimates for the Federal 

Direct Loan Program, what are the key cash flow assumptions, how 

sensitive are Education’s subsidy costs to changes in these assumptions, 

and what data are used to support these assumptions?

An effective approach to identifying key cash flow assumptions is to 

perform a detailed analysis of all cash flow assumptions—called a 

sensitivity analysis11—in order to determine which assumptions have the 

greatest impact on the estimated cost of FDLP. Education told us that it 

performs informal analyses of the cash flow assumptions that result in 

about 90 percent of the change in subsidy costs each year. However, 

Education did not provide any supporting documentation for this analysis. 

Further, Education told us that it has not performed a sensitivity analysis of 

all cash flow assumptions in its model. As this type of analysis would be 

extremely time-consuming, we requested that Education perform and 

document a limited sensitivity analysis as a basis on which to answer this 

question. Based on this limited sensitivity analysis, there were seven key 

cash flow assumptions that when adjusted, had a significant impact on the 

estimated cost of the loan program. These assumptions were discount 

rates, borrower rates, loan maturity, collections on previously defaulted 

loans, defaults, origination fees, and when repayments begin.12 The analysis 

showed that FDLP’s subsidy cost was most sensitive to changes in the 

discount rate and borrower rate. While some of the data supporting these 

key assumptions are provided by other agencies or specified by law, 

Education supported other assumptions by using a combination of 

guaranteed loan program and economic data, a reasonable approach, since 

the direct loan program is relatively new and limited historical data are 

available. 

11Currently, there is no accounting or budgeting guidance that requires agencies to perform a 

sensitivity analysis. However, Technical Release 3 encourages agencies to perform this 

analysis.

12Additional key cash flow assumptions may be identified once Education performs a more 

thorough sensitivity analysis.
Page 16 GAO-01-197 FDLP Cost Estimates

Key Cash Flow Assumptions To ensure that all key assumptions have been identified, and to determine 

how sensitive Education’s subsidy cost estimates are to changes in key 

assumptions, Education would have to conduct a thorough sensitivity 

analysis. According to Technical Release 3, one approach to perform such 

an analysis is to individually adjust each assumption by a fixed proportion 

(e.g., increased and decreased by 10 percent) and run the revised cash 

flows through the OMB Credit Subsidy Calculator13 to determine the 

assumption’s effect on the estimated subsidy cost. Timing assumptions for 

when defaults and collections occur and when repayments begin should 

also be adjusted in a systematic manner. Those assumptions that when 

adjusted, caused the largest change in the subsidy cost are determined to 

be the key cash flow assumptions.

Education budget staff told us that they perform analyses of the cash flow 

assumptions that result in about 90 percent of the change in subsidy cost 

each year when they prepare budget estimates and reestimates. However, 

they do not maintain documentation of these analyses. Education has also 

done sensitivity analysis on the larger guaranteed loan program, which 

Education uses to help identify the key assumptions for the FDLP. 

However, because Education’s cash flow model has a large number14 of 

assumptions, there is no assurance that all key assumptions have been 

identified through the informal analyses that Education performed for 

FDLP. Because a formal analysis of all cash flow assumptions would take a 

significant amount of time, we asked Education to perform and document a 

limited sensitivity analysis of the assumptions it believed to be key and 

added two other assumptions related to the largest loan types, risk groups, 

and repayment options that we felt might also be key.

13To provide a consistent, common approach to calculate the present value of credit 

program costs, OMB developed the Credit Subsidy Calculator, formerly known as the OMB 

Credit Subsidy Model, a computer software program that calculates a subsidy rate based on 

agency-generated estimates of cash flows to and from the government. It also calculates the 

portions of the subsidy cost attributable to defaults, interest, fees, and other cash flows.

14Education told us that its cash flow model has over 1,900 assumptions because it models 

cash flows for all 56 loan profiles—the type of loan, the type of school the student attends, 

and in some cases the year of schooling for the student and the repayment option selected—

separately. Therefore, in the cash flow model, each loan profile has its own set of 

assumptions. Although the type of assumptions is generally the same for each loan profile, 

the value of these assumptions often differ. 
Page 17 GAO-01-197 FDLP Cost Estimates

Based on the results of the limited sensitivity analysis, we determined that 

seven of the nine cash flow assumptions tested were key.15 These 

assumptions follow.

• Discount rate − this rate is used to calculate the present value of the 

expected future cash flows of the loan program and the interest portion 

of the subsidy cost.16 This rate is generally the same rate at which 

agencies borrow funds from Treasury.

• Borrower rate − the interest rate borrowers pay Education for their 

loans. This rate is based on the 91-day Treasury bill plus various add-on 

amounts that range from 1.7 percent to 3.1 percent with a maximum 

borrower rate of 8.25 percent or 9.0 percent depending on loan type.

• Loan maturity − the time it takes for a loan to be paid in full. Loan 

maturity varies depending on loan amount and repayment option 

selected by the borrower. Generally, borrowers have from 10 to 30 years 

to repay their loans.17

• Collection rate − the percentage of defaulted loan amounts subsequently 

recovered through Education’s collection process.

• Default rate − the percentage of principal that will not be paid because 

of borrower defaults. 

• Origination fee − the fee borrowers pay to Education to obtain a loan.

• Beginning repayment − the percentage of loans beginning to make 

principal and interest repayments each quarter.18

As a result of the limited sensitivity analysis, two of the additional 

assumptions that we requested be included in the analysis were identified 

as key assumptions—loan maturity and origination fees. Loan maturity is 

important because it sets the amount of time borrowers are expected to 

take to repay their loans and, accordingly, the number of years Education 

estimates that it will receive interest payments from borrowers. The 

origination fee assumption is important because it determines the amount 

of fee receipts Education will receive. There could also be other key 

assumptions that will not be identified until Education completes a 

15Each of the assumptions identified as key produced a change of at least 2 percent and 

$13 million in the estimated cost of any single loan profile tested. 

16The subsidy cost is calculated based on four portions attributed to interest, defaults, fees, 

and other cash flows.

17Repayment begins at the conclusion of any deferment period. 

18Education’s cash flow model estimates cash flows by fiscal year quarter.
Page 18 GAO-01-197 FDLP Cost Estimates

thorough sensitivity analysis. Identification of key assumptions is 

important to ensure proper monitoring of those assumptions and to adjust 

future subsidy estimates for changes in assumptions. 

Sensitivity of Subsidy to Changes 

in Key Assumptions

Tables 4 and 5 summarize the results of the sensitivity analysis for seven of 

the nine cash flow assumptions tested, which entailed adjusting each 

assumption by a set amount to determine the impact on the subsidy cost. 

For borrower and discount rates, loan maturity, loan origination fee, and 

default and collection rates, this adjustment involved increasing and 

decreasing by 10 percent the values currently in the cash flow model. For 

the assumption related to timing—the beginning repayment assumption—

the adjustment involved was an annual acceleration of 5 percent to the 

amount of loans beginning repayment in the first 5 years of the loan term. 

While the tables show the impact of decreasing the assumptions, similar 

results were obtained by increasing the assumptions. Because changes in 

two of the nine cash flow assumptions tested had very little impact on the 

overall subsidy cost, they were not determined to be key and were 

excluded from the table.19 Table 4 presents the results of the analysis in 

terms of the percentage change in the subsidy cost of each loan profile, 

which encompasses the type of loan, the type of school the student attends, 

and in some cases the year of schooling for the student and the repayment 

option selected.20 Generally, the higher the percentage, regardless of 

whether it was positive or negative, the more sensitive the subsidy cost was 

to change in this assumption. The loan profiles are as follows.

• Loan Profile 1 − Represents loans to freshmen and sophomore students 

attending 4-year schools who have obtained Stafford Subsidized loans 

and chose the standard repayment option.

• Loan Profile 2 − Represents loans to junior and senior students 

attending 4-year schools who have obtained Stafford Unsubsidized 

loans and chose the standard repayment option.

• Loan Profile 3 − Represents loans to junior and senior students 

attending 4-year schools who have obtained Stafford Unsubsidized 

loans and chose the graduated repayment option.

19The two assumptions that were determined not to be key assumptions were the timing of 

defaults and collections.

20The sensitivity analysis that Education performed was based on Education’s fiscal year 

2001 mid-session review cash flow model and assumptions.
Page 19 GAO-01-197 FDLP Cost Estimates

• Loan Profile 4 − Represents PLUS loans to parents of freshmen and 

sophomore students attending 4-year schools who chose the standard 

repayment option.

• Loan Profile 5 − Represents Consolidation loans to borrowers who 

chose the extended repayment option.

• Loan Profile 6 − Represents Consolidation loans to borrowers who 

chose the income contingent repayment option.

Table 4: Percentage Impact of Changes in Key Assumptions on Subsidy Costs by 

Loan Profile

a

According to Education, the income contingent repayment option does not have a specific loan 

maturity assumption due to the nature of the income contingent repayment option. 

b

According to Education, no collections are estimated to be received on defaulted loan amounts 

because borrower defaults are estimated to be insignificant.

c

The default rate assumption for loan profile 6 was not tested as part of the sensitivity analysis 

because, according to Education, defaults are an insignificant portion of the subsidy cost compared to 

the other subsidy components. This is because borrower repayments are based on borrowers’ 

financial ability to repay loans.

d

Consolidation loans do not charge an origination fee.

e

Repayments for Consolidation loans are considered to begin in the first year.

Source: Department of Education.

Table 5 presents the estimated dollar impact on the subsidy cost of each 

loan profile for the fiscal years 1995 through 1999 cohorts based on the 

results of the sensitivity analysis. These loan profiles represent $16.7 billion 

of FDLP loans disbursed during that time.

Assumption

Loan

profile 1

Loan

profile 2

Loan

profile 3

Loan

profile 4

Loan

profile 5

Loan

profile 6

Discount rate -23.0% -33.6% -37.2% -36.4% -101.9% -21.4%

Borrower rate 10.5% 28.7% 29.6% 25.8% 80.1% 20.9%

Loan maturity 3.4% 5.8% 5.0% 13.9% 19.5% Not

applicablea

Collection rate 5.4% 5.2% 3.1% 4.0% 18.6% Not

applicableb

Default rate -4.6% -2.8% -1.9% -5.8% -18.0% Not

applicablec

Origination fee 2.1% 2.2% 1.2% 3.9% Not

applicabled

Not

applicabled

Beginning 

repayment

-4.3% -.4% -.5% -8.7% Not

applicablee

Not

applicablee
Page 20 GAO-01-197 FDLP Cost Estimates

Table 5: GAO Estimates of Dollar Impact of Changes in Key Assumptions on 

Subsidy Costs by Loan Profile 

a

According to Education, the income contingent repayment option does not have a specific loan 

maturity assumption due to the nature of the income contingent repayment option. 

b

According to Education, no collections are estimated to be received on defaulted loan amounts 

because borrower defaults are estimated to be insignificant.

c

The default rate assumption for loan profile 6 was not tested as part of the sensitivity analysis 

because, according to Education, defaults are an insignificant portion of the subsidy cost compared to 

the other subsidy components. This is because borrower repayments are based on borrowers’ 

financial ability to repay loans.

d

Consolidation loans do not charge an origination fee.

e

Repayments for Consolidation loans are considered to begin in the first year.

Based on results of the analysis in tables 4 and 5, the estimated cost of 

FDLP was clearly most sensitive to changes in the discount rate and the 

borrower rate. Loan maturity also showed a relatively high level of 

sensitivity for all six loan profile costs. Tables 4 and 5 further demonstrate 

that the impact of changing these assumptions differs among loan profiles. 

For example, the subsidy costs of all six loan profiles showed a large 

degree of sensitivity to changes in the discount rate and the borrower rate, 

indicating that changes in these assumptions would significantly affect the 

estimated cost of FDLP, with the largest effect on a percentage basis for 

loan profile 5−Consolidation loans with the extended repayment option. 

This would likely be the case because these loans begin repayment in the 

first year and generally have longer repayment periods, thus magnifying the 

impact of interest changes. It is especially important to monitor 

assumptions displaying this high level of sensitivity because even a small 

(Dollars in millions)

Assumption

Loan

profile 1

Loan

profile 2

Loan

profile 3

Loan

profile 4

Loan

profile 5

Loan

profile 6

Discount rate $(149.6) $(159.3) $(103.1) $(65.7) $(150.0) $(153.2)

Borrower rate 68.4 136.0 81.9 46.5 118.0 150.0

Loan maturity 22.1 27.5 13.8 25.0 28.7 Not

applicablea

Collection rate 35.4 24.4 8.6 7.2 27.4 Not

applicableb

Default rate (30.2) (13.2) (5.3) (10.4) (26.5) Not

applicablec

Origination fee 13.7 10.5 3.2 7.0 Not

applicabled

Not

applicabled

Beginning 

repayment

(27.8) (1.7) (1.4) (15.8) Not

applicablee

Not

applicablee
Page 21 GAO-01-197 FDLP Cost Estimates

change in them can have a significant impact on the estimated cost of the 

loan program. 

Data Supporting Key Cash Flow 

Assumptions

Table 6 summarizes the sources of data Education used to support the 

seven key cash flow assumptions identified in the sensitivity analysis.

Table 6: Summary of Key Assumptions and Sources of Data

a

OMB prepares various economic forecasts that agencies use when preparing their budget estimates. 

Generally, these data include estimates of various short and long-term interest rates, unemployment 

rates, and inflation rates.

b

This January 1999 study proposes an approach to modeling, among other things, loan repayments, 

defaults, and collections on defaulted loans using data from Education’s National Student Loan Data 

System (NSLDS), which primarily contains data from FFELP. In this study, the contractors also 

considered OMB’s economic forecasts. 

As shown in table 6, for two of the seven key cash flow assumptions, data 

sources are provided by other agencies. Specifically, the borrower rate and 

discount rate are generally provided by OMB and updated based on actual 

Treasury interest rates, or set by the 91-day Treasury Bill rate from the last 

auction in May conducted by Treasury. These rates, the most significant of 

Assumption Source of information 

Discount rate This rate is provided by OMB each year for use governmentwide.a

The discount rate used for each cohort is fixed and determined by 

the interest rates prevailing during the period that the cohort’s 

loans were disbursed.

Borrower rate The actual borrower rate is primarily based on the 91-day Treasury 

bill from the last Treasury Marketable Securities Auction in May of 

each year. Projections of future borrower rates needed in the cash 

flow model to estimate FDLP subsidy costs are based on OMB 

economic assumptions related to 91-day Treasury bill rates.

Loan maturity The maximum allowable loan maturity is set by statute and varies 

depending on loan amount and repayment option. For estimating 

FDLP subsidy costs, the maximum allowable loan maturity is 

decreased based on data from FFELP to reflect the average length 

of time it historically took borrowers to fully repay their loans. This 

decrease is calculated to account for prepayments or 

consolidations that fully pay off a loan balance.

Origination fee The fee amount is specified by statute but has been adjusted by 

the Secretary.

Default rate

Collection rate

Beginning 

repayment

A contractor prepared study that includes (1) historical data for 

FFELP, (2) the limited FDLP historical data that were available, and 

(3) economic data related to inflation and unemployment.b
Page 22 GAO-01-197 FDLP Cost Estimates

the key assumptions, are determined externally and are outside of 

Education’s control. 

For most of the key cash flow assumptions in our analysis, Education used 

FFELP data because they were the best available data.21 SFFAS No. 2 states 

that agencies should use the historical experience of the loan program 

when estimating future loan performance. However, since FDLP has only 

existed since 1994, and Education estimates that average loan maturities 

range from 9 to 27 years, Education lacks adequate historical data to 

estimate future performance of the loan program. According to Technical 

Release 3, agencies may use the experience of other federal or private 

sector loan programs when estimating the cost of new loan programs that 

lack adequate historical data. These data, often referred to as proxy data, 

should be an interim step to gathering the appropriate historical data upon 

which to base future estimates of loan performance. Education officials 

told us that Education is currently accumulating the actual cash flow data 

for the direct loan program and plans to continue phasing out the use of 

proxy data in the future.

Without performing a more thorough sensitivity analysis, Education may 

not identify all key assumptions in its FDLP cash flow model. Knowledge of 

these key assumptions would provide management with the ability to more 

efficiently monitor the economic trends and cash flow assumptions that 

most affect the loan program’s financial performance and, accordingly, to 

prepare reasonable estimates of the program’s cost. While some of the 

changes in assumptions−particularly those related to interest rates−occur 

outside Education’s control, understanding the impact that changes in 

assumptions have on program costs also would provide management with 

a tool to help predict the impact of certain policy changes on the cost of the 

program. 

Question 4 How closely do Education’s subsidy cost estimates and their underlying 

assumptions compare to actual loan performance for each loan and to what 

extent does Education track differences between its subsidy cost estimates 

and actual loan performance for each loan cohort?

21These assumptions were reviewed by Education’s independent public accountant as part 

of the fiscal year 1999 financial statement audit and found to be reasonable in all material 

respects.
Page 23 GAO-01-197 FDLP Cost Estimates

Prior to this request, Education had not done a formal documented analysis 

comparing estimated subsidy costs to actual loan performance for FDLP. 

Typically, such an analysis would entail comparing estimated cash flows 

included in the cash flow model to actual cash flows recorded in the 

agency’s financial systems. However, as discussed below, actual cash flow 

data from Education’s financial systems were not totally comparable to the 

data used in the cash flow model. While we were able to determine 

differences between estimated and actual cash flows for certain of the key 

assumptions, sufficient detailed information was not available to assess the 

reasons for most of the differences. Based on our analysis, some significant 

differences between the estimated and actual cash flows were noted. 

Although Education could not identify the specific reasons for some of 

these fluctuations, Education updates its assumptions for actual interest 

rates and loan performance when calculating reestimates.

Comparing Estimated to Actual 

Cash Flows

Education’s analysis of estimated and actual loan performance for FDLP, 

prepared at our request, compared estimated to actual cash flows related 

to five of the seven key cash flow assumptions identified in question 3—the 

borrower rate, loan maturity, beginning repayment assumption,22

origination fees, and collections on defaulted loans.23 The comparison did 

not include any analysis of defaults because Education was unable to 

readily provide comparable data on either estimated or actual defaults. Due 

to the nature of direct loan programs, Education’s FDLP cash flow model 

estimates principal and interest payments that will be missed in a given 

fiscal year as a result of a default, while Education’s financial systems do 

not specifically recognize this “absence of cash flow.” Rather, the financial 

systems report defaults as entire loan amounts that are written off in a 

given fiscal year. Further, the overall analysis was limited by the fact that 

readily available data in the financial systems were not totally comparable 

to the data available in the cash flow model. Specifically, Education’s 

financial systems lacked readily available data at the cohort and loan 

profile level. Education therefore used fiscal year totals from the financial 

systems in its analysis. Appropriately performing an analysis of estimated 

to actual cash flows would require having readily available actual data as 

22In order to produce the estimated cash flows for interest and principal receipts, Education 

considers the borrower rate, loan maturity, and beginning repayment assumptions.

23The discount rate assumption was not included because it does not directly affect 

borrower-related cash flows. Rather, this assumption is used to calculate the present value 

of the cash flows and the financing component of the subsidy cost.
Page 24 GAO-01-197 FDLP Cost Estimates

captured in the cash flow model−by cohort, key cash flow assumption, and 

loan profile. 

Although agencies are not required to compare estimated cash flows to 

actual cash flows on a cohort basis, such an approach would provide a 

more meaningful analysis than comparing fiscal year totals. According to 

Education, its approach is consistent with standard credit reform practice 

in which costs for all loan cohorts are reestimated each year using the 

latest cash flow model and assumptions. However, Education’s budget 

officials have acknowledged that their analysis has certain limitations. For 

example, the difference between estimated and actual loan performance 

could be understated because of offsetting differences among different 

cohorts. Further, because Education’s analysis compared loan performance 

in total, variances in loan performance within individual cohorts may 

become minimized. These variances may indicate anomalies or trends that 

were not expected when the credit subsidy estimate was originally 

calculated. 

Because we were unable to analyze specific cohorts included in 

Education’s analysis, we were unable to determine whether, over time, 

estimated cash flows became more predictive of actual cash flows. 

Education officials told us that they are currently working to obtain a 

subsidiary ledger that will provide readily available data that are 

comparable to data in the cash flow model to allow for a comparison of 

estimated cash flows to actual cash flows on a cohort level. 

Even though cohort-level data were not available, we were able to analyze 

estimated cash flows and actual cash flows on an overall basis for certain 

key cash flow assumptions. As shown in table 7, and figures 1 through 4, 

some of Education’s estimated cash flows varied significantly from actual 

cash flows in total and by fiscal year.
Page 25 GAO-01-197 FDLP Cost Estimates

Table 7: Total Estimated and Actual Key Cash Flows for Fiscal Years 

1995 Through 1999 

Source: Department of Education.

For three of the four key cash flows—interest receipts, origination fees and 

default collections—included in this comparison, actual cash flows were 

less than the amount Education estimated. As shown in table 7, from fiscal 

years 1995 through 1999, the largest variance occurred between 

Education’s estimated and actual interest receipts. In total, Education 

received about $1.6 billion less than expected during this 5-year period. In 

contrast, Education received about $392 million more principal receipts 

during the same period. Of the four key cash flows included in table 7, 

Education’s estimated origination fees had the least amount of a 

percentage variance. From fiscal years 1995 through 1999, actual 

origination fees were $87 million, nearly 6 percent less than estimated. 

In addition to significant variances in total, some of Education’s estimated 

to actual cash flows varied significantly within individual fiscal years. For 

example, as shown by figures 1 and 4, significant variances occurred 

between the estimated and actual amounts of both interest receipts and 

collections on defaulted loans in fiscal years 1998 and 1999. In contrast, as 

shown in figure 3, with the exception of those in fiscal year 1995, 

Education’s estimates of origination fees were relatively close to the actual 

amounts received in all fiscal years. During fiscal years 1996 through 1999, 

differences between estimated and actual origination fees varied from 

about 1 percent to about 6 percent. 

(Dollars in millions)

Key cash flows 

Actual cash

flows

Estimated

cash flows

Difference in

dollars

Percentage

difference

Interest receipts $2,100 $3,660 $(1,560) (74.3)%

Principal receipts 3,068 2,676 392 12.8%

Origination fees 1,524 1,611 (87) (5.7)%

Default collections 81 136 (55) (67.9)%

Total $6,773 $8,083 $(1,310) (19.3)%
Page 26 GAO-01-197 FDLP Cost Estimates

Figure 1: Estimated and Actual Interest Receipts 

(Dollars in millions)

Source: Department of Education.

According to Education, the main reason for the significant difference 

between estimated and actual interest receipts is the way its cash flow 

model handles loan consolidations. Typically, the original loans that are 

consolidated into a new loan would be treated as prepayments, and 

estimated future cash flows from these underlying loans should be 

eliminated in the cash flow model. However, Education’s cash flow model 

does not adjust for prepayments. Education currently compensates for this 

by shortening the loan maturity in an attempt to reflect the consolidation or 

prepayment of the original underlying loans. However, this approach may 

misstate the timing and characterization of cash flows reported annually. 

For example, when borrowers consolidate their loans, accrued interest on 

the original loans is added to the principal balance for some loan types, 

while the borrower is in school and in other deferment situations. When 

borrowers repay their loans, some of the payment for accrued interest is 

shown in the accounting records as payments of principal. According to 

Education, this helps explain the differences depicted in figure 2 where 

more principal was received than estimated for 4 of the 5 years included in 

our review. However, because Education was unable to provide the 

supporting data for this explanation, we were unable to verify whether the 

way consolidations are modeled is (1) truly the primary cause of the 

$1,921

$1,045

$492

$169 $32

$1,067

$606

$300

$113 $15

$0

$500

$1,000

$1,500

$2,000

$2,500

1995 1996 1997 1998 1999

Estimated Actual
Page 27 GAO-01-197 FDLP Cost Estimates

significant difference between the estimated and actual interest receipts 

from borrowers and (2) a key factor in differences in principal receipts.

Figure 2: Estimated and Actual Principal Receipts 

(Dollars in millions) 

Source: Department of Education.

According to Education’s budget staff, they are analyzing the method used 

to allocate borrower repayments between principal and interest, and they 

acknowledged that they are not totally comfortable with the current split. 

In addition, as discussed in question 6, Education has been working to 

improve its modeling of consolidations and plans to develop a different 

cash flow model that will allow Education to model and track cash flows at 

the individual loan level. Education’s budget staff told us that they believe 

this new cash flow model will address most of the problems they face in 

modeling consolidations. 

$1,481.0

$750.1

$326.1

$100.8

$18.0

$1,584.9

$940.7

$299.1

$213.8

$29.5

$0

$300

$600

$900

$1,200

$1,500

$1,800

1995 1996 1997 1998 1999

Estimated Actual
Page 28 GAO-01-197 FDLP Cost Estimates

Figure 3: Estimated and Actual Origination Fees 

(Dollars in millions) 

Source: Department of Education.

The largest difference between estimated and actual origination fees 

occurred in fiscal year 1995. According to an Education budget official, this 

difference was due to a reporting anomaly that caused Education to 

underreport the amount of actual origination fee data. Because Education 

was unable to provide any supporting documentation for this explanation, 

we were unable to verify whether this was the actual cause of the 

difference.

$128.0

$319.7

$373.6

$397.6 $392.5

$85.3

$317.5

$352.4

$382.0 $386.6

$0

$100

$200

$300

$400

$500

1995 1996 1997 1998 1999

Estimated Actual
Page 29 GAO-01-197 FDLP Cost Estimates

Figure 4: Estimated and Actual Collections on Defaults 

(Dollars in millions) 

Source: Department of Education.

Figure 4 shows that Education’s actual collections on defaulted loans were 

less than estimated collections. However, because Education’s cash flow 

model estimates collections as a percentage of the amount of loans that 

default, and we did not receive any information on defaults, neither we nor 

Education are able to determine the underlying cause of the difference. 

According to SFFAS No. 2, for credit program managers, information on 

estimated default losses and related liabilities, when recognized promptly, 

can be an important tool in evaluating credit program performance. This 

information can help determine a credit program’s overall financial 

condition and identify its financing needs. 

Tracking Differences Between 

Actuals and Estimates

Education prepared reestimates that accounted for, in aggregate, the 

differences between estimated and actual loan performance. However, 

because it lacked data captured by loan profile, cohort, and key 

assumption, Education was limited in its ability to identify the underlying 

causes of amounts reestimated. See question 1 for a discussion of 

reestimates for fiscal years 1995 through 1999. 

Prior to this review, most of Education’s analysis of estimated to actual 

loan performance had been performed for FFELP, rather than for FDLP, 

$89.1

$36.8

$8.5

$0.1 $1.2

$64.3

$15.4

$1.0 $0.0 $0.0

$0

$20

$40

$60

$80

$100

1995 1996 1997 1998 1999

Estimated Actual
Page 30 GAO-01-197 FDLP Cost Estimates

because the guaranteed program is significantly larger than the direct loan 

program and historical data supporting the direct loan program estimates 

was limited. In using FFELP data, Education officials believed that the two 

loan programs’ performance would be similar. However, up until 1993, 

FFELP only offered borrowers the standard repayment option and 

currently only two of FFELP’s three repayment plans are similar to those 

offered under FDLP. Therefore, FFELP historical data may not prove very 

predictive of FDLP, which offers primarily four repayment options. These 

repayment options would likely affect the timing and amount of cash flows; 

however, under existing guidance, Education may use FFELP data as a 

proxy for actual historical data to support some of the key cash flow 

assumptions for FDLP, as discussed in question 3. Without a separate 

analysis specific to FDLP, Education has limited information about how 

well its estimates for FDLP track with actual cash flows. 

Based on the information provided by Education for fiscal years 1995 

through 1999, total actual cash inflows were less than estimates for three of 

the four key cash flows. Most notably, a significant difference exists 

between the estimated and actual amount of interest receipts Education 

receives from borrowers. While Education officials provided an 

explanation, supporting evidence was not provided to corroborate their 

explanation. Even though differences between estimated and actual cash 

flows are expected, and the reestimation process allows Education an 

opportunity to adjust its estimates of future cash flows based on actual 

experience, better understanding the causes of significant variances would 

help Education more effectively estimate FDLP costs. However, without 

the cohort, loan type, and cash flow assumption-level data, Education’s 

ability to assess whether its cash flow model is reasonably predicting 

borrower behavior is limited. As a result, Education lacks critical 

information necessary to update future cash flow models. In addition, 

Education’s inability to provide an analysis of defaults, one of the key cash 

flow assumptions, further impedes Education’s ability to effectively predict 

future cash flows.

Question 5 What effect have reduced loan origination fees had on subsidy costs, and 

how has Education taken account of these changes in its subsidy cost 

estimates and reestimates?
Page 31 GAO-01-197 FDLP Cost Estimates

In August 1999, Education reduced its origination fees for FDLP student 

loans from 4 percent to 3 percent.24 According to Education, this reduction 

was done in order to ensure that both FDLP and FFELP borrowers receive 

the same terms, conditions, and benefits. As a result of the fee reduction, 

Education’s subsidy cost estimates for the fiscal year 200125 cohort show an 

increase of approximately $93 million, or 23 percent, compared to what 

would have been estimated with the 4 percent fee. However, Education 

officials reported26 that they believed that the overall effect would be cost 

neutral when considered in light of the higher subsidy costs associated 

with guaranteeing loans under FFELP. 

Since the fee reduction occurred late in the fiscal year, and thus applied to 

a limited amount of the fiscal year 1999 loan volume, Education did not 

take account of the fee reduction in its reestimates prepared in December 

1999. However, in the President’s Budget for fiscal year 2001, subsidy 

estimates reflect the fee reduction, and Education plans to continue 

accounting for the change in origination fees, in accordance with 

applicable guidance for federal credit agencies. 

Effect of Loan Origination Fee 

Reduction

Education reduced the student loan origination fee from 4 percent to 3 

percent for the Stafford Subsidized and Stafford Unsubsidized loan types in 

August 1999, which resulted in increased subsidy costs for these loan types 

of approximately $55 million and $38 million, or 13 percent and 6 percent, 

respectively, in the fiscal year 2001 cohort estimate. This amounted to a 

$93 million, or a 23 percent, increase in the overall FDLP subsidy cost 

estimate for the fiscal year 2001 cohort, compared to what it would have 

24GAO issued an opinion (B-283717, September 29, 1999) regarding the Secretary’s authority 

to enact regulations authorizing origination fee reductions in FDLP. Education asserted that 

it was authorized to reduce loan origination fees in FDLP commensurate with those 

provided in FFELP. Education relied upon the Higher Education Act of 1965, as amended, 

which requires that both FDLP borrowers and FFELP borrowers receive the same terms, 

conditions, and benefits on their loans, unless otherwise specified. GAO concluded that the 

regulations conflict with a statutory requirement that Education charge a 4 percent 

origination fee. Several of the Secretary’s actions, including reducing loan origination fees in 

FDLP, have been challenged in a lawsuit filed by lenders participating in FFELP. Student 

Loan Finance Corp. et. al v. Riley, C.A. 00-2660, (U.S. District Court for the District of 

Columbia filed November 3, 2000). This report is not intended to nor does it express an 

opinion on the issues in the lawsuit.

25This estimate was prepared in December 1999 for the fiscal year 2001 President’s Budget.

26Cost of the 1999 Reduction in Direct Loan Fees, Budget Service, U.S. Department of 

Education, October 7, 1999.
Page 32 GAO-01-197 FDLP Cost Estimates

been assuming the same loan volumes. The fee reduction did not apply to 

the PLUS loan type’s origination fee, which remained at 4 percent, or the 

Consolidation loan type, which does not charge an origination fee to 

borrowers. 

Since the overall FDLP subsidy cost is a weighted average determined by 

the subsidy costs of the four FDLP loan types and their loan volumes, the 

increase in the overall FDLP subsidy cost depends on the loan amounts 

made for each loan type−known as the mix of loans. Table 8 summarizes 

the increases to FDLP subsidy cost estimates for each loan type due to the 

fee reduction, as well as the estimated mix of loans in fiscal year 2001. 

Table 8: Effect of Fee Reduction on Subsidy Costs

Source: Department of Education.

In their report, Cost of the 1999 Reduction in Direct Loan Fees, Education 

officials recognized that the fee reduction would increase the cost for 

FDLP. However, they believed that the increase would be offset by the 

ability to attract borrowers to FDLP who might otherwise obtain loans 

from the more costly FFELP whose lenders, according to Education 

officials, were offering interest and fee discounts to attract borrowers. For 

the fiscal year 2001 cohorts, FDLP’s cost was a net inflow of about $3 per 

$100 in loans versus FFELP’s cost of about $11 per $100 in loan 

guarantees.27

Increase in subsidy

costs per $100 in

direct loans

Increase in subsidy

costs based on

fiscal year 2001

loan mix

Estimated

fiscal year 2001

loan mix

Stafford subsidized $1.04 $55 million 35%

Stafford unsubsidized 0.94 38 million 26%

PLUS 0.00 - 8%

Consolidation 0.00 - 31%

Overall FDLP $0.60 $93 million 100%

27Costs are based on estimates of the 2001 cohorts included in the Federal Credit 

Supplement: Budget of the United States Government, fiscal year 2001.
Page 33 GAO-01-197 FDLP Cost Estimates

How Education Considered the 

Fee Reduction in Its Subsidy 

Costs

The first time the fee reduction could have been taken into account was in 

Education’s subsidy cost estimates and reestimates prepared in December 

1999. The fee reduction was factored into Education’s subsidy cost 

estimates of the fiscal year 2000 and 2001 cohorts prepared in December 

1999 for the fiscal year 2001 President’s Budget. However, given that the fee 

reduction did not take effect until August 1999, Education did not factor 

the fee reduction into its fiscal year 1999 reestimates because it applied to 

only a small amount of the fiscal year 1999 loan volume. Education has 

stated that the fee reduction will be incorporated into the fiscal year 1999 

cohort reestimate of subsidy costs prepared for the fiscal year 2002 

President’s Budget.

Question 6 What effects have increased consolidations had on subsidy costs, and how 

has Education taken account of these changes in its subsidy cost estimates 

and reestimates?

By obtaining an FDLP Consolidation loan, borrowers can combine their 

loans from different federal student loan programs into a new single loan 

and make one monthly payment. Consolidation loans accounted for 

45 percent of new direct loan dollars disbursed in fiscal year 1999 and 

26 percent of total FDLP direct loan dollars outstanding as of 

September 30, 1999. While it is clear that the volume of Consolidation loans 

is increasing, determining the effects of consolidations is difficult because 

many factors need to be considered, including loan maturity, prepayments, 

borrower rates, and discount rates. In order to properly consider all of 

these factors, an extensive loan-by-loan analysis of cash flows, applying 

scenarios with and without a consolidation, would be required. Since 

Education has not performed this type of detailed analysis, there is no way 

of knowing the impact of increased consolidations on subsidy costs for 

FDLP.

Education estimates and reestimates the subsidy cost of Consolidation 

loans similarly to the other FDLP loan types. For the original underlying 

loans, a consolidation is in essence a loan prepayment. Education factors 

both the consolidation of the underlying loans and prepayments into FDLP 

subsidy cost estimates and reestimates by shortening the loan maturity 

assumption, which affects the time estimated for loan repayments to be 

received. While adjusting for consolidations and other prepayments 

through the maturity assumption may at least partially take into account 

the cash flow changes over time, as discussed in question 4, it is likely to 

result in misstatements and mischaracterization of cash flows reported 
Page 34 GAO-01-197 FDLP Cost Estimates

annually. Education officials told us that they recognize the limitations of 

their current approach and are working to develop an approach to analyze 

the impacts of consolidations and other prepayments and how they can be 

appropriately factored into their cash flow model.

Question 7 What effect have declining interest rates had on subsidy costs, and how has 

Education taken account of these changes in its subsidy cost estimates and 

reestimates?

Interest rates can affect subsidy costs directly through borrower rates and 

discount rates and indirectly through borrower behavior. When the 

borrower rate is greater than the discount rate, Education will receive 

more interest from borrowers than it will pay in interest to Treasury to 

finance its loans. This has been the situation over the short life of FDLP. 

Because Education’s cash flow model is continually being updated and 

previous versions of the cash flow model with original assumptions were 

not fully maintained, it was not possible to determine the precise effect on 

subsidy costs of changes in interest rate versus changes in other cash flow 

assumptions. However, it is clear that the decline in interest rates from 

1995 through 1999 has had a greater impact on discount rates than 

borrower rates because of the borrower rate cap. This has resulted in an 

increased interest rate spread−the difference between the borrower rate 

and discount rate−that has contributed to FDLP’s estimated negative 

subsidy for the fiscal year 1999 cohort. Education accounts for interest rate 

changes in total in its annual reestimates. 

Declining Interest Rates’ Effect 

on Subsidy Costs

The two types of interest rates that are used to estimate the subsidy costs 

of FDLP are the borrower rate and discount rate. 

• The borrower rate determines the amount of interest charged to 

borrowers. The borrower rate for the Stafford Subsidized, Stafford 

Unsubsidized, and PLUS loan types is variable—adjusted annually—and 

is based on the 91-day Treasury bill28 plus various add-on amounts that 

have ranged from 1.7 percent to 3.1 percent depending on the loan type 

and the borrower repayment status, with a maximum borrower rate of 

8.25 percent or 9.0 percent depending on the loan type. The borrower 

28The actual borrower rate is based on the 91-day Treasury bill rate from the last Treasury 

Marketable Securities Auction in May. Future borrower rates, needed in the cash flow model 

to estimate FDLP subsidy costs, are based on OMB projections of 91-day Treasury bill rates.
Page 35 GAO-01-197 FDLP Cost Estimates

rate for Consolidation loans made after February 1, 1999, is fixed and 

calculated based on the weighted average of the borrower rates of the 

loans that were consolidated, with a maximum allowable rate of 8.25 

percent. As the borrower rate declines, Education receives less interest 

from the borrower and, all else being equal, the subsidy cost of FDLP 

increases.

• The discount rate is the interest rate used to calculate the present value 

of the estimated future cash flows and is generally equal to the rate at 

which interest is paid by Education on the amounts borrowed from or 

held by Treasury. The discount rate used for each cohort is fixed and 

determined by the interest rates prevailing during the period that the 

cohort’s loans were disbursed (normally such disbursement occurs 

within 2 years of loan origination for FDLP). Therefore, the discount 

rate can differ significantly among cohorts. This is important because 

cohorts with lower discount rates have a lower borrowing cost and, as a 

result, a lower subsidy cost compared to an otherwise identical cohort 

with a higher discount rate. 

As discussed more fully in question 8, since 1995, FDLP borrower rates 

have been greater than the discount rates, which has resulted in a positive 

interest rate spread, as shown in figure 5. However, the spread was not 

significant enough in the early years of the program to cover other subsidy 

costs, such as defaults and interest subsidies. In fiscal year 1999, the spread 

became large enough to result in an estimated negative subsidy. 
Page 36 GAO-01-197 FDLP Cost Estimates

Figure 5: FDLP Borrower Rates and Discount Rates

Source: Department of Education.

Beyond the direct effect of changes in interest rates on borrower and 

discount rates, interest rates can also affect borrower behavior, which, in 

turn, can affect defaults and prepayments and ultimately, subsidy costs. 

Given all these variables and the fact that interest rate fluctuations are 

nearly impossible to predict with any certainty, continued changes in FDLP 

subsidy costs should be expected.

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

1995 1996 1997 1998 1999

Borrower Rate with up to a 3.1% add-on

Discount Rates
Page 37 GAO-01-197 FDLP Cost Estimates

How Education Takes Account 

of Interest Rate Changes

In order to calculate its subsidy cost estimates, Education uses OMB 

economic assumptions29 related to future interest rates for its borrower 

rate and discount rate assumptions. As part of the reestimate process, 

Education updates its borrower rate and discount rate assumptions based 

on actual interest rates and revised OMB economic assumptions. 

Education has not prepared separate interest rate reestimates, as required 

by OMB Circular A-11. However, Education told us that its method of 

reestimating FDLP subsidy costs has been accepted by OMB in the past. 

Specifically, Education accounted for changes in discount rates as part of 

its technical reestimate process.30 As a result, Education is unable to 

readily provide a historical analysis of the impact on subsidy costs due to 

changes in discount rates. Education staff have stated that at the request of 

OMB, interest rate reestimates will be prepared as part of the reestimate 

process for the fiscal year 2002 President’s Budget. 

Question 8 What are the future prospects for the continued negative subsidy for the 

Federal Direct Loan Program?

Education’s most recent estimates of the fiscal year 1999 through 2001 

cohorts indicate a negative subsidy cost. However, we cannot predict with 

any certainty the future prospects for the continued estimated negative 

subsidy for FDLP because it is a relatively new program with limited 

historical data and is very sensitive to fluctuations in interest rates and 

other factors. Based on the results of the sensitivity analysis, discussed in 

question 3, and the effects of interest rate fluctuations on subsidy costs, the 

primary factor determining whether FDLP has a negative or positive 

subsidy is the difference, or spread, between the borrower rate and 

discount rate. When the borrower rate is greater than the discount rate, 

Education will receive more interest from borrowers than it will pay to 

Treasury for borrowing funds, which increases the likelihood of a negative 

subsidy. Conversely, when the borrower rate is less than the discount rate, 

Education will pay more in interest to Treasury than it will receive from 

borrowers, which decreases the likelihood of a negative subsidy. However, 

several other factors, including defaults and consolidations, could also 

affect whether the estimated subsidy continues to be negative. While some 

29OMB issues certain economic assumptions for use governmentwide in order to prepare 

each year’s President’s Budget. These assumptions include projections of interest rates, 

unemployment rates, and inflation rates.

30See appendix I for a discussion of interest rate and technical reestimates.
Page 38 GAO-01-197 FDLP Cost Estimates

conditions are more favorable than others for a continued estimated 

negative subsidy, whether and for how long a negative subsidy remains in 

effect is unclear at this time and greatly depends on future interest rates. 

Interest Rates’ Effect on the 

Possibility of a Negative Subsidy

While other factors do come into play, interest rates are the key factor in 

assessing the future cost of FDLP. In the limited history of FDLP, large 

fluctuations in interest rates have not been experienced. Figure 6 shows 

the trend of the 91-day Treasury bill rate, which is used to determine 

borrower rates, over the past 20 years. The shaded area shows the history 

of FDLP, a period during which interest rates have been relatively stable.

Figure 6: Historical 91-Day Treasury Bill Rates

Source: The Bureau of the Public Debt.

The difference between the borrower rate and discount rate, or spread, is a 

key driver of subsidy costs. This spread can be analyzed to help determine 

the likelihood of a negative subsidy. The greater the spread, the more likely 

a negative subsidy will result. 

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

Year

Interest rate

91-day Treasury Bill rates
Page 39 GAO-01-197 FDLP Cost Estimates

As discussed in question 7, the current estimated negative subsidy has 

primarily been a result of borrower rates being greater than discount rates, 

which will result in Education receiving more interest from borrowers than 

it will pay for funds borrowed from Treasury. This condition results in a 

positive spread. In the earlier years of FDLP, the spread did not offset other 

subsidy costs, such as defaults and interest subsidies. Fiscal year 1999 was 

the first year that the positive spread resulted in a negative subsidy. 

Education has estimated that this will continue through fiscal year 2001. 

If the discount rate were higher than the borrower rate, a negative subsidy 

would be unlikely because the spread would no longer be positive. This 

could easily occur because interest rates can fluctuate significantly over 

time and the discount rate for a cohort of loans is fixed and determined by 

interest rates prevailing during the cohort’s disbursement period, while 

borrower rates are variable for three of the four FDLP loan types and 

capped at a maximum allowable rate.

Other Factors That Affect 

Continued Negative Subsidy

Fiscal year 1995 was the first full fiscal year of existence for FDLP and as of 

September 30, 1999, only about 54 percent of FDLP outstanding loan 

amounts were in repayment status because of the deferred payment terms 

offered under this program. As a result, there is limited historical data 

related to loan repayments, defaults, and consolidations, among other 

things, to use as a basis for a prediction on the future behavior of 

borrowers and the impact this will have on subsidy costs. 

While positive spreads increase the possibility of a continued negative 

subsidy for FDLP, other factors that increase costs or reduce cash inflows 

decrease the likelihood of a negative subsidy. For example, less favorable 

macroeconomic conditions, such as high unemployment, will likely result 

in increased defaults, or if there are further reductions in loan origination 

fees, the cost of the program increases and, thus, the likelihood of a 

negative subsidy decreases. The mix of loans among the four loan types 

could also have an impact on whether an overall negative subsidy 

continues, because not all loan types, which have separate subsidy cost 

estimates, have negative subsidies. For example, the Stafford Subsidized 

loan type subsidizes interest for students while they are in school. Because 

this is a significant cost of the Stafford Subsidized loan type, it may always 

have a positive subsidy cost regardless of the spread. Therefore, if the 

FDLP portfolio were to have a larger portion of Stafford Subsidized loans, 

this new mix of loans would reduce the likelihood of a negative subsidy. 

Further, as discussed in question 6, since the effect on subsidy costs due to 

consolidations is unknown at this time, and depends on future interest 
Page 40 GAO-01-197 FDLP Cost Estimates

rates and the future performance of these Consolidation loan borrowers, 

the increase in Consolidation loan volume could also have a significant 

impact on the future prospects for continued negative subsidies.

Question 9 What data did Education use to project an estimated savings of $4 for every 

$100 of direct student loans, as it reported in November 1999?

In projecting an estimated savings of $4 for every $100 of direct student 

loans, Education netted the estimated negative subsidy and the 

administrative costs per $100 of loans. To do this, Education used its 

subsidy cost estimate reported in the budget for the fiscal year 2000 midsession review for the subsidy cost portion of the total cost. This estimate 

is based on the types of data described in the response to question 3. To 

estimate the federal administrative cost portion, Education used contract 

expenditure data as well as data from its accounting system, OMB’s cost 

inflation factors, and historical data.31 These estimated savings pertained 

only to the fiscal year 2000 cohort. Education chose the fiscal year 2000 

cohort because (l) congressional interest in the federal student loan 

programs was future-oriented and (2) the data available for estimating 

costs for the fiscal year 2000 cohort were more accurate and complete than 

the data available for earlier cohorts. However, the projected savings will 

not necessarily occur with other cohorts and may not continue to occur for 

the fiscal year 2000 cohort, depending on future interest rate fluctuations. 

Table 9 displays comparative cost estimates for the direct loan program for 

the fiscal year 2000 and fiscal year 2001 cohorts. These data show how 

changes in subsidy cost estimates can affect total cost estimates over a 

relatively short period. The first column shows the initial administrative, 

subsidy, and total cost estimates reported in Education’s November 1999 

cost study for the fiscal year 2000 cohort. As shown in the table, the total 

program cost could change from $4.11 in cost savings for every $100 in 

loans for the fiscal year 2000 cohort to 58 cents in costs for every $100 in 

loans for the fiscal year 2001 cohort. 

31Incorporating Federal Administrative Costs into FFEL and Direct Loan Program Cost 

Estimates, U.S. Department of Education, November 1999. In this study, Education 

developed an approach to compare the total costs of the two programs by calculating both 

subsidy and federal administrative costs on a net present value basis. The study constituted 

a first step in developing baseline long-term unit cost estimates for use in future cost 

accounting and performance measurement systems within Education’s Office of Student 

Financial Assistance. 
Page 41 GAO-01-197 FDLP Cost Estimates

Table 9: Comparative Direct Loan Program Estimates, Per $100 of Loans

a

Fiscal year 2000 mid-session review estimate.

b

Based on Education’s cost estimate presented in the Federal Credit Supplement: Budget of the 

United States Government, fiscal year 2001.

c

Department of Education estimate presented in Incorporating Federal Administrative Costs into 

FFELP and Direct Loan Program Cost Estimates, U.S. Department of Education, November 1999.

Source: Department of Education. 

For the fiscal year 2001 cohort, the negative subsidy declined from $7.73 to 

$3.04. An Education official explained that the increase in the subsidy cost 

for the fiscal year 2001 cohort is due to changes in the spread between the 

borrower rate and the discount rate. Education officials also believe that 

the underlying assumptions used to project the administrative cost will not 

change significantly from one cohort to the next since they are not highly 

sensitive to changes in loan volume. In a similar cost study, issued in March 

1999, Education’s Office of Inspector General concluded that in any given 

year, either FFELP’s or FDLP’s costs (e.g., subsidy and administrative) 

could be greater depending on how prevailing economic conditions affect 

subsidy costs.32

(Dollars in millions)

Fiscal year 2000

cohort (initial

estimate)

Fiscal year 2001

cohort

Subsidy cost estimates $(7.73)a $(3.04)b

Federal administrative cost 

estimatesc

3.62 3.62

Total $(4.11) $0.58

32Study of Cost Issues: Federal Family Education Loan Program and the Federal Direct Loan 

Program, U.S. Department of Education, Office of Inspector General, March 1999.
Page 42 GAO-01-197 FDLP Cost Estimates

To develop and assign administrative costs to the direct loan program, 

Education used certain costs specified in OMB guidance as well as 

historical costs (such as costs in relevant contracts, salaries, rent, and 

travel).33 These costs include any expenditure associated with program 

support activities such as processing applications, serving customers, and 

disbursing and collecting loans. Table 10 shows the types of data Education 

used to estimate the administrative cost of the direct loan program. 

Table 10: Primary Types of Data Used in Education’s 1999 Cost Study

a

Contracts analyzed include those for the operation and support of the following information 

management systems: National Student Loan Data System, Direct Loan Origination, Direct Loan 

Servicing, Direct Loan Central Data System, Central Processing System, Stafford/Perkins Data 

Systems, Multiple Data Entry, the Postsecondary Education Participants System, Title IV Wide-Area 

Network, and the Public Inquiry Contract.

Education officials told us that some data on actual overhead costs were 

taken from Education’s cost accounting system (for example, salaries, 

expenses, and rent) and Office of Student Financial Assistance (OSFA) 

records. Education projected the administrative costs over the expected 

life of all the loans in the fiscal year 2000 cohort using predetermined 

inflation factors that existed in many of the contracts, OMB inflation 

factors, or a combination of historical data and OMB inflation factors.

33OMB Circular A-11 defines administrative expenses as all costs directly related to credit 

program operations, including (l) all activities related to credit extension, loan servicing, 

write-off, and closeout, (2) all loan systems development and maintenance, including 

computer costs, (3) all monitoring of credit programs and private lenders for compliance 

with laws and regulations, (4) the cost of operating separate offices that make policy 

decisions for credit programs, (5) the cost of collecting delinquent loans, and (6) the 

proportion of administrative expenses shared with noncredit programs.

Types of data Purpose 

Agency contract expenditure dataa

 To estimate cost of contracts (e.g., volume of 

applications processed each year, student loans 

originated and serviced, and defaulted student 

loan collections) and other related loan activity 

costs. 

Education’s accounting system data To gather data on overhead costs (for example, 

personnel, training, travel, rent, and postage). 

OMB cost inflation factors and 

historical expenditure data 

To estimate the lifetime cost of direct loan 

activities.
Page 43 GAO-01-197 FDLP Cost Estimates

To develop the lifetime federal administrative cost estimates, Education 

first assigned costs to one of three categories—loan origination, servicing 

or account maintenance, or overhead. It then applied a three-step approach 

to calculate these costs, by cohort and type, for FDLP and FFELP. The 

approach included

• developing the annual spending levels for the two loan programs based 

on volume-driven costs that depend on the number of loans or similar 

activity measures, such as the number of loan applications, and on 

nonvolume-driven costs including personnel and fixed costs, such as 

rent and travel, that do not depend on the number of loans or similar 

activity measures;

• assigning annual spending for each loan program; and 

• calculating the net present value of future administrative cost by cohort. 

To assign administrative costs to each loan program, Education used 

designated funding sources, loan volume, and self-developed cost 

assumptions. Any costs involving both grants and loans, such as 

application processing, were allocated to the loan programs based on the 

proportion of loan recipients to grant recipients. Any cost for activities 

common to both loan programs was assigned based on annual projections 

of the number of borrowers in each program. Overhead costs were 

assigned to the two loan programs based on the source of funds. For 

example, overhead expenses funded using section 458 of the Higher 

Education Act were assumed by Education to be used for FDLP even 

though some of these funds are used for FFELP costs. In using this 

assumption, Education believes that it is overstating the portion of 

overhead costs attributable to the direct loan program. 

Education projected administrative costs over 50 years—fiscal years 2000 

through 2050. The 50-year period was used to reflect the maximum amount 

of time that all borrowers in a cohort could be in school, in a deferment or 

forbearance period, making loan repayments, or making payments on loan 

defaults. After consulting with Education, we concluded that performing 

this analysis over a shorter period—within the 9 to 27-year range Education 

uses in estimating subsidy costs—would not produce significantly different 

results. 

Education chose not to include several cost items in its calculation of 

administrative cost for the loan programs. These included costs for 

information system upgrades and improvements that Education believes 

could reduce future per loan costs of delivering financial aid. Education 
Page 44 GAO-01-197 FDLP Cost Estimates

officials did not include these costs because the specific components of 

these system upgrades had not been determined at the time the study was 

issued, and they believe the initial cost will be offset by future savings. 

However, the study did not include a cost analysis to support this belief. To 

the extent that these costs are not offset by future savings in other cost 

categories, Education’s administrative cost estimates will be understated. 

According to its budget proposal, Education plans to spend $48.5 million on 

information systems modernization for student aid programs in fiscal year 

2001.

Education excluded loan origination costs for consolidation loans because 

provisions of FCRA—section 502(5)(B)(iii)—include fees as a subsidy cost. 

Additionally, Education chose not to include noncontract costs associated 

with offices outside OSFA since these costs only represented $3.2 million 

of a total $600 million and included no more than 32 personnel. 

OSFA is currently developing a cost allocation model that will identify the 

total administrative cost for each of the major financial aid programs as 

well as the per unit cost of delivering each loan or grant award. OSFA plans 

to use this model to identify areas where it can reduce these per-unit 

delivery costs and to assess how well it is accomplishing these reductions. 

Unlike the November 1999 cost study, the OSFA model will include 

noncontract costs from other offices within Education that have a role in 

delivering student financial aid. It will use data primarily from Education’s 

accounting system to determine total and per unit costs. 

While this administrative cost information will be useful, changes in the 

subsidy costs from one cohort to the next are the primary drivers of total 

program costs. Subsidy costs, in turn, are primarily affected by interest 

rates and therefore cannot be predicted with any certainty.

Conclusions Developing reasonable estimates of subsidy costs for loan programs is a 

complex task. Numerous assumptions must be taken into account and 

projections must be made for the estimated life of the loans, which could 

be up to 30 years. Because FDLP’s subsidy costs are determined largely by 

interest rates—specifically the difference, or spread, between the borrower 

and discount rates—and since interest rate fluctuations cannot be 

predicted with any certainty, it is uncertain that the current trend in 

negative subsidy costs for FDLP will continue. A change in interest rates, 

for example, can cause a negative subsidy to become positive. Even with 
Page 45 GAO-01-197 FDLP Cost Estimates

improvements to Education’s cash flow model, it is important to recognize 

that estimates of subsidy costs are sensitive to interest rate volatility.

That being said, there are also other factors that affect the subsidy cost of 

FDLP, such as origination fees paid by borrowers, defaults, subsequent 

collections on defaulted loans, and the timing of loan repayments. While 

Education is able to estimate origination fees close to the actual amounts in 

the financial systems, the other key cash flows varied significantly. These 

cash flows are primarily estimated based on looking at the history of how 

borrowers perform under the conditions provided by each loan type within 

FDLP. Because the program is relatively new, Education has primarily used 

the history of FFELP as a basis for its FDLP estimates. While this is 

reasonable given that it is the best historical data available, it may not be 

very predictive of FDLP borrower behavior because FDLP offers different 

repayment options than those reflected in most of the historical data 

related to FFELP. 

Additionally, Education’s current model for estimating FDLP subsidy costs 

does not directly take into account certain key factors, such as 

prepayments and consolidations. This limitation hinders Education’s ability 

to determine the impacts of consolidation activities, which are increasing 

significantly. Also, Education was unable to provide actual data related to 

defaults, which are a key assumption. Finally, the fact that Education does 

not currently have the information readily available to make meaningful 

comparisons of estimated to actual cash flows, and, most important, to 

identify the reasons for differences, significantly impedes Education’s 

ability to refine future estimates based on actual results. Therefore, the 

reliability of Education’s subsidy cost estimates is negatively affected not 

only by the volatility of interest rates but also by limitations in the 

department’s ability to monitor and adjust for other key factors in its 

subsidy cost estimation process. Education is aware of these limitations 

and has efforts underway to begin to address them. 

Recommendations for 

Executive Action

To provide more meaningful cost estimation information that can be 

effectively used by Congress and program decisionmakers to make timely 

and well-informed judgments about FDLP, we recommend that the 

Secretary of the Department of Education charge the Budget Director, who 

has overall responsibility for preparing FDLP cost estimates, to take the 

following actions:
Page 46 GAO-01-197 FDLP Cost Estimates

• Develop and implement a method to acquire actual cash flow data on 

the same basis as the cash flow model−by loan profile, cohort, and key 

assumption−to facilitate a detailed comparison of estimated to actual 

cash flows.

• Formalize and document the sensitivity analysis of assumptions 

included in the FDLP cash flow model to ensure that all key 

assumptions used in the cash flow model have been identified and to 

determine the sensitivity of FDLP subsidy costs to changes in these 

assumptions. 

• Develop and implement a method of routinely comparing FDLP’s 

estimated and actual cash flows, including

• identifying significant differences in total and by cohort, 

• researching significant differences to determine the specific cause, 

• determining any revisions needed in the cash flow model to ensure 

that it reasonably predicts future borrower behavior, and

• determining whether, over time, projected loan performance is 

reasonably predictive of actual loan performance. 

• Perform an analysis of the effects of consolidations on FDLP subsidy 

costs and develop an approach to directly factor consolidations into the 

cash flow model.

• Develop and implement a plan to prepare interest rate reestimates to 

isolate the effects on subsidy costs of changes in interest rates versus 

changes in other assumptions.

• Refine the administrative cost modeling so that the costs of computer 

system upgrades are incorporated, as well as the cost savings that would 

result from these upgrades. 

Agency Comments We provided the Department of Education copies of a draft of this report 

for review and comment. On December 7, 2000, we met with cognizant 

Education officials and obtained oral comments on a draft of this report. 

Education officials generally agreed with our answers to the questions, 

findings, conclusions, and recommendations. Education is in the process of 

taking actions to address some of these recommendations. For example, 

Education officials told us that they are currently working to obtain a 

subsidiary ledger that will provide readily available data that are 

comparable to data in the cash flow model to allow for a comparison of 

estimated to actual cash flows on a cohort level. Further, Education is in 

the process of researching and modeling the effects of consolidations on 

subsidy cost estimates. Education also provided technical comments, 

which we have incorporated as appropriate.
Page 47 GAO-01-197 FDLP Cost Estimates

We are sending copies to the Secretary of Education and other interested 

parties. Copies will also be made available to others upon request.

Please contact either Linda M. Calbom at (202) 512-9508 or Cornelia M. 

Ashby at (202) 512-8403, if you or your staffs have any questions 

concerning this report. Key contacts and major contributors to this report 

are listed in appendix III.

Linda M. Calbom

Director, Financial Management and

Assurance 

Cornelia M. Ashby

Director, Education, Workforce and

Income Security Issues
Page 48 GAO-01-197 FDLP Cost Estimates

Appendix I

Estimating Credit Program Costs ApApenednxidexiIs

The Federal Credit Reform Act of 1990 (FCRA) was enacted to require 

agencies to more accurately measure the government's cost of federal loan 

programs and to permit better cost comparisons both among credit 

programs and between credit and noncredit programs. FCRA assigned to 

OMB the responsibility for coordinating the cost estimates required by the 

act. OMB is authorized to delegate to lending agencies the authority to 

estimate costs, based on its own written guidelines. These guidelines are 

contained in OMB Circular A-11, sections 85.1 through 85.12, and 

supporting exhibits,1

 as well as other OMB guidance, including OMB 

Circular A-34, Instructions on Budget Execution, and other documents. 

The Federal Accounting Standards Advisory Board (FASAB)2

 developed 

the accounting standard for credit programs, SFFAS No. 2, Accounting for 

Direct Loans and Loan Guarantees, which became effective in fiscal year 

1994. This standard, which generally mirrors FCRA, established guidance 

for estimating the cost of direct and guaranteed loan programs as well as 

recording direct loans and the liability for loan guarantees for financial 

reporting purposes. 

The actual and expected costs of federal credit programs should be fully 

recognized in both budgetary and financial reporting. To determine the 

expected cost of a credit program, agencies are required to predict or 

estimate the future performance of the program. This cost, known as the 

subsidy cost, is the present value3

 of disbursements—over the life of the 

loan—by the government (loan disbursements and other payments) minus 

estimated payments to the government (repayments of principal, payments 

of interest, other recoveries, and other payments). For loan guarantees, the 

subsidy cost is the present value of cash flows from estimated payments by 

1

The act requires OMB to coordinate with the Congressional Budget Office in developing 

estimation guidelines.

2

FASAB was created by OMB, Treasury, and GAO to consider and recommend accounting 

principles for the federal government. These three agencies approved Statement of Federal 

Financial Accounting Standards (SFFAS) No. 2, Accounting for Direct Loans and Loan 

Guarantees, in July 1993 and SFFAS No. 18, Amendments to Accounting Standards for 

Direct Loans and Loan Guarantees in SFFAS No. 2 in May 2000.

3

Present value is the worth of the future stream of returns or costs in terms of money paid 

immediately. In calculating present value, prevailing interest rates provide the basis for 

converting future amounts into their “money now” equivalents. For the period we reviewed, 

when calculating the present value of loan subsidy costs, agencies were required to use as 

the discount rate the average annual interest rate for marketable U.S. Treasury securities 

with similar maturities to the loan or guarantee. 
Appendix I

Estimating Credit Program Costs

Page 49 GAO-01-197 FDLP Cost Estimates

the government (for defaults and delinquencies, interest rate subsidies, and 

other payments) minus estimated payments to the government (for loan 

origination and other fees, penalties, and recoveries).

To estimate the cost of loan programs, agencies first estimate the future 

performance of direct and guaranteed loans when preparing their annual 

budgets. The data used for these budgetary estimates should be 

reestimated to reflect any changes in loan performance since the budget 

was prepared. These reestimated data are then used in financial reporting 

when calculating the allowance for subsidy (the cost of direct loans), the 

liability for loan guarantees, and the cost of the program. In the financial 

statements, the actual and expected costs of loans disbursed as part of a 

credit program are recorded as a “Program Cost” on the agencies' 

Statement of Net Costs for loans disbursed. 

In addition to recording the cost of a credit program, SFFAS No. 2 requires 

agencies to record direct loans on the balance sheet as assets at the present 

value of their estimated net cash inflows. The difference between the 

outstanding principal balance of the loans and the present value of their net 

cash inflows is recognized as a subsidy cost allowance—generally the cost 

of the direct loan program. For guaranteed loans, the present value of the 

estimated net cash outflows, such as defaults and recoveries, is recognized 

as a liability and generally equals the cost of the loan guarantee program.

In preparing SFFAS No. 2, FASAB indicated that the subsidy cost 

components—interest, defaults, fees, and other cash flows—would be 

valuable for making credit policy decisions, monitoring portfolio quality, 

and improving credit performance. Thus, agencies are required to 

recognize, and disclose in the financial statement footnotes, the four 

components of the credit subsidy—interest, net defaults, fees and other 

collections, and other subsidy costs—separately for the fiscal year during 

which direct or guaranteed loans are disbursed. 

In addition, nonauthoritative guidance is contained in the previously 

discussed Technical Release of the Credit Reform Task Force of the 

Accounting and Auditing Policy Committee, entitled Preparing and 

Auditing Direct Loan and Loan Guarantee Subsidies Under the Federal 

Credit Reform Act. This Technical Release provides detailed 

implementation guidance for agency staff on how to prepare reasonable 

credit subsidies. Further, the Technical Release provides suggested 

procedures for auditing credit subsidy estimates.
Appendix I

Estimating Credit Program Costs

Page 50 GAO-01-197 FDLP Cost Estimates

Developing Cash Flow 

Assumptions and 

Models

In estimating cash flows, Education and other credit agencies are required 

to predict borrower behavior−how many borrowers will pay early, pay late, 

or default on their loans and at what point in time. Generally, the subsidy 

costs equal the amount of estimated losses to the federal government and 

are financed with appropriated funds. The portion of Education's direct 

loans that Education predicts will ultimately be collected is financed by 

borrowing from Treasury. For example, a hypothetical FDLP loan of $100 

may have a subsidy cost of $20 (the amount Education expects to lose), 

which is financed with appropriated funds, and the remaining $80 is 

financed by Treasury borrowings (the amount Education expects to be 

repaid).

Budgeting guidance requires agencies to maintain supporting 

documentation for subsidy cost estimates. Further, auditing standards 

related to preparing estimates indicate that agency management is 

responsible for accumulating relevant, sufficient, and reliable data on 

which to base the estimates. SFFAS No. 2 indicates that each credit 

program should use a systematic methodology to project expected cash 

flows into the future. To accomplish this task, agencies should develop 

cash flow models. A cash flow model is a computer program that generally 

uses historical information and various assumptions, including defaults, 

prepayments, recoveries, and the timing of these events, to estimate future 

loan performance. These cash flow models, which should be based on 

sound economic, financial, and statistical theory, identify key factors that 

affect loan performance. Agencies use this information to make more 

informed predictions of future credit performance. The August 1994 User's 

Guide to Version r.8 of the OMB Credit Subsidy Model provides general 

guidance on creating cash flow models to estimate future delinquencies, 

defaults, recoveries, etc. This user's guide states that, “In every case, the 

agency or budget examiner must maintain current and complete 

documentation and justification for the estimation methods and 

assumptions used in determining the cash flow figures used for the OMB 

Subsidy Model” to calculate the credit subsidy.

According to SFFAS No. 2, to estimate the cost of loan programs and 

predict the future performance of credit programs, agencies should 

establish and use reliable records of historical credit performance. Since 

actual historical experience is a primary factor upon which estimates of 

credit performance are based, agencies should maintain a database, also 

known as an information store, at the individual loan level, of historical 

information on all key cash flow assumptions, such as defaults or 
Appendix I

Estimating Credit Program Costs

Page 51 GAO-01-197 FDLP Cost Estimates

recoveries, used in calculating the credit subsidy cost. Additional 

nonauthoritative guidance on cash flow models may be found in the Model 

Credit Program Methods and Documentation for Estimating Subsidy Rates 

and the Model Information Store issue paper prepared by the Credit 

Reform Task Force of the Accounting and Auditing Policy Committee. This 

draft “Information Store” Task Force paper provides guidance on the type 

of historical information agencies need to reasonably estimate the cost of 

credit programs. The information store should provide three types of 

information. First, the information store should maintain key loan 

characteristics at the individual loan level, such as the loan terms and 

conditions. Second, it should track economic data that influence loan 

performance, such as property values for housing loans. Third, an 

information store should track historical cash flows on a loan-by-loan 

basis. The data elements in an information store should be selected to 

allow for more in-depth analyses of the most significant subsidy estimate 

assumptions.

In addition to using historical databases and the cash flow models, other 

relevant factors must be considered by agencies to estimate future loan 

performance. These relevant factors include

• economic conditions that may affect the performance of the loans,

• financial and other relevant characteristics of borrowers,

• the value of the collateral to loan balance,

• changes in recoverable value of collateral, and

• newly developed events that would affect loan performance.

When new programs are established or changes are made to existing 

programs, historical supporting documentation for cash flow assumptions 

may not exist. In the absence of valid, relevant historical experience, the 

agency may use relevant experience from other federal or private sector 

loan programs. These data, often called proxy data, should be temporarily 

used while the agency collects adequate historical data for the new or 

revised loan program. 

Reestimating Credit 

Subsidies

Agencies prepare estimates of loan program costs as a part of their budget 

requests. Later, after the end of the fiscal year, agencies are required to 

update or “reestimate” loan costs for differences among estimated loan 

performance and related cost, the actual program costs recorded in the 

accounting records, and expected changes in future economic 

performance. The reestimate should include all aspects of the original cost 
Appendix I

Estimating Credit Program Costs

Page 52 GAO-01-197 FDLP Cost Estimates

estimate, including prepayments, defaults, delinquencies, recoveries, and 

interest. Reestimates of the credit subsidy allow agency management to 

compare the original budget estimates with actual program results to 

identify variances from the original estimate, assess the quality of the 

original estimate, and adjust future program estimates as appropriate. Any 

increase or decrease in the estimated cost of the loan program is 

recognized as a subsidy expense or a reduction in subsidy expense for both 

budgetary and financial statement purposes.

The reestimate requirements for interest rate and technical assumptions 

(defaults, recoveries, prepayments, fees, and other cash flows) differ. For 

budget purposes, OMB Circular A-11 states that agencies must reestimate 

the interest portion of the estimate when a cohort is substantially disbursed 

or generally when at least 90 percent of the direct loans or guaranteed 

loans are disbursed. The technical reestimate, for budgetary purposes, 

generally must be done annually, after the close of each fiscal year as long 

as the loans are outstanding, unless OMB approves a different plan,4

regardless of financial statement significance. For financial statement 

reporting purposes, both technical and interest rate reestimates are 

required annually, at the end of the fiscal year, whenever the reestimated 

amount is significant to the financial statements. If there is no significant 

change in the interest portion of the estimate prior to the loans being 

90 percent disbursed, then the interest rate reestimate may be done once 

when the loans are at least 90 percent disbursed. In addition, SFFAS No. 18, 

which was effective beginning in fiscal year 2001, requires that reestimates 

be measured and reported in two separate components: interest rate 

reestimates and technical/default reestimates.

Interest rate reestimates are made to adjust the credit subsidy estimate for 

the difference between the discount rate originally estimated and the actual 

interest rates prevailing during the years the loan was disbursed. To 

calculate the size of this effect, all other assumptions (repayment rates, 

default rates, etc.) must be the same as those used to calculate the original 

subsidy estimate. Technical reestimates are made to adjust for all changes 

in assumptions other than interest rates. The purpose of the technical 

4

The OMB representative with primary budget authority may authorize agencies to calculate 

technical reestimates for budgetary purposes less frequently than every year when any one 

of four conditions are met: (1) based on periodic schedules established in coordination with 

OMB, (2) when a major change in actual versus projected activity is detected, (3) when a 

significant difference is detected through monitoring “triggers” developed in coordination 

with OMB, and (4) when a group of loans are being closed out.
Appendix I

Estimating Credit Program Costs

Page 53 GAO-01-197 FDLP Cost Estimates

reestimate is to adjust the subsidy estimate for differences between the 

original projection of cash flows and the amount and timing of expected 

cash flows based on actual experience, new forecasts of future economic 

conditions, and other events and improvements in the methods used to 

estimate future cash flows. 
Page 54 GAO-01-197 FDLP Cost Estimates

Appendix II

Objectives, Scope, and Methodology ApendxiI

This report responds to your request and that of the former Chairman of 

the House Committee on the Budget that we prepare a report on the 

financing of Education's William D. Ford Federal Direct Loan Program 

(FDLP). To respond to your request, for fiscal years 1995 through 1999 we 

reviewed Education's audited financial statements and examined the 

workpapers of Education's Independent Public Accountants. We 

interviewed knowledgeable personnel from Education's budget office and 

obtained information relevant to the questions we were asked to answer. 

We assessed Education's credit subsidy estimation practices against 

federal accounting and budget standards, including SFFAS No. 2, 

Accounting for Direct Loans and Loan Guarantees; OMB Circular A-11, 

Preparation and Submission of Budget Estimates; and guidance contained 

in the Federal Financial Accounting and Auditing Technical Release 3, 

Preparing and Auditing Direct Loan and Loan Guarantee Subsidies Under 

the Federal Credit Reform Act. The scope and methodology for responding 

to each of the nine questions you asked is discussed as follows.

Question 1 How much financing has been provided to Education for the direct loan 

program through borrowing from Treasury and appropriations received?

We obtained from Education schedules of borrowings from Treasury, 

repayments to Treasury, and appropriations received for fiscal years 1995 

through 1999. We verified the schedules of Treasury borrowing to data 

contained in the workpapers of Education's Independent Public 

Accountant. We obtained schedules of original subsidy estimates and 

reestimates for fiscal years 1995 through 1999 cohorts. We verified the 

subsidy appropriations to Education's original documentation, SF132 

reports on Apportionment and Reapportionment, and schedule 1151s to 

return negative subsidy to Treasury. 

Question 2 Have cash inflows (excluding borrowings from Treasury and borrower 

principal repayments) exceeded cash outflows (excluding repayments to 

Treasury and loan disbursements)?

Data relating to loan origination fees, interest receipts from borrowers, and 

net interest payment on Treasury borrowings were obtained from the 

Appendix to the President's Budget for fiscal years 1997 through 2001, 

which contained actual data for the fiscal years 1995 through 1999. We also 

verified fiscal years 1995, 1996, and 1997 actual cash flows to Education's 

statement of cash flows in its financial statements. For fiscal years 1998 
Appendix II

Objectives, Scope, and Methodology

Page 55 GAO-01-197 FDLP Cost Estimates

and 1999, we verified the actual data to cash collection amounts provided 

by Education's financial systems.

Question 3 In Education's calculation of its subsidy cost estimates for FDLP, what are 

the key cash flow assumptions, how sensitive are Education's subsidy 

costs to changes in these assumptions, and what data are used to support 

these assumptions?

To gain an understanding of Education's cash flow model, we reviewed 

Education's model documentation, the workpapers of Education's 

independent public accountant, and various reports. To identify which of 

the over 1,900 cash flow assumptions were key cash flow assumptions, we 

first discussed with Education budget staff what cash flow assumptions 

they believed were key cash flow assumptions for FDLP based on their 

prior analyses. Since much of the data used to estimate the cost of FDLP 

are proxy data from FFELP, we determined what cash flow assumptions 

were key cash flow assumptions for FFELP based on the independent 

public accountant's workpapers. Based on our experience with other 

federal credit programs, we identified other assumptions that we believed 

may also be key. We then conducted an analysis of FDLP to identify the 

most significant loan profiles, which includes the loan type, risk category, 

and repayment option.

To determine how sensitive FDLP's cost was to changes in these key 

assumptions, we requested that Education budget staff conduct a limited 

sensitivity analysis of the assumptions they thought might be key as well as 

the other assumptions we identified. In instructing Education on how to 

perform the sensitivity analysis, we generally followed the guidance 

contained in the Federal Financial Accounting and Auditing Technical 

Release 3, Preparing and Auditing Direct Loan and Loan Guarantee 

Subsidies Under the Federal Credit Reform Act1

 and requested that 

1

The Credit Reform Task Force of the Accounting and Auditing Policy Committee was 

formed in order to address key issues surrounding the implementation of FCRA and the 

related federal accounting standard. This task force developed Technical Release 3, which is 

expected to be formally issued by OMB during fiscal year 2001. The purpose of Technical 

Release 3 is to provide implementation guidance for agencies and auditors to prepare, 

utilize, and report on credit subsidy estimates. Technical Release 3 does not take 

precedence over existing accounting standards and budget guidance. Currently, these 

standards and guidance do not require agencies to perform a sensitivity analysis; however, 

Technical Release 3 encourages agencies to perform this analysis.
Appendix II

Objectives, Scope, and Methodology

Page 56 GAO-01-197 FDLP Cost Estimates

Education increase and decrease by 10 percent the value of each nontiming 

related assumption presumed to be key. Because timing assumptions are 

modeled differently, and should also be adjusted in a systematic manner, 

we requested that Education increase the amount of the loans in the 

beginning repayment assumption by 5 percent during the first 5 years to 

simulate a decrease in the time it took borrowers to repay their loans. 

We analyzed the results of the limited sensitivity analysis and determined 

that any assumption that produced a change of at least 2 percent and 

$13 million in the estimated cost of any single loan profile tested was a key 

cash flow assumption. We then met with agency officials to identify the 

data sources for key cash flow assumptions. 

Question 4 How closely do Education's subsidy cost estimates and their underlying 

assumptions compare to actual loan performance for each loan cohort and 

to what extent does Education track differences between its subsidy cost 

estimates and actual loan performance for each loan cohort?

We compared cash flows related to five of the seven key cash flow 

assumptions identified in question 3 (interest payments, principal 

payments, default rate, origination fees, and collections on defaulted loans) 

and obtained estimated and actual cash flow data for fiscal years 1995 

through 1999. Due to the nature of direct loan programs, the comparison 

did not include any analysis of defaults because Education was unable to 

readily provide comparable data on estimated and actual defaults. The 

discount rate assumption was not included because it does not directly 

affect the amount or timing of cash flows. Rather, this assumption is used 

to estimate the present value of the cash flows. Because the actual cash 

flow data in Education's financial systems were not totally comparable to 

data available in the cash flow model (by cohort, key cash flow assumption, 

and loan profile), Education obtained actual cash flow data on fiscal year 

totals from its financial systems for its analysis. 

For estimated cash flows, original cash flow models from fiscal years 1995 

through 1999 were not fully maintained, thus, we used Education's analysis 

using its current cash flow model and assumptions for each fiscal year 

beginning with 1995. We verified that the actual cash flow data provided 

agreed to the amounts reported in Education's budget submissions. We 

also verified fiscal year 1995, 1996, and 1997 actual cash flows to 

Education's statement of cash flows in its financial statements. For fiscal 

years 1998 and 1999, we verified the actual data to cash collection amounts 
Appendix II

Objectives, Scope, and Methodology

Page 57 GAO-01-197 FDLP Cost Estimates

provided by Education's financial systems. For total cash flows for fiscal 

years 1995 through 1999, we then compared estimated to actual cash flows 

to determine the amount of the difference. We met with Education budget 

staff to determine and request supporting documentation for the causes of 

these differences. Since supporting documentation was unavailable, we 

were unable to corroborate Education's explanations for these differences.

Question 5 What effect have reduced loan origination fees had on subsidy costs, and 

how has Education taken account of these changes in its subsidy cost 

estimates and reestimates?

To determine the impact of reduced loan origination fees on subsidy costs, 

we requested that Education calculate the credit subsidy costs for FDLP 

overall and each of the four loan types with the origination fee equal to 

4 percent and 3 percent. We analyzed the results of the calculation and 

discussed with Education personnel how they accounted for the reduced 

loan origination fees in subsidy cost estimates and reestimates. 

Question 6 What effects have increased consolidations had on subsidy costs, and how 

has Education taken account of these changes in its subsidy cost estimates 

and reestimates?

To assess the impact of increased consolidations, we discussed 

consolidations with Education personnel, including how they work, their 

history, and how consolidations are modeled in subsidy cost estimates and 

reestimates. We determined the various factors that could affect how 

consolidations effect FDLP subsidy costs. Because Education had not 

performed the detailed analysis necessary to determine the actual effect of 

consolidations, we were unable to determine the impact of increased 

consolidations on subsidy costs for FDLP.

Question 7 What effect have declining interest rates had on subsidy costs, and how has 

Education taken account of these changes in its subsidy cost estimates and 

reestimates?

Because Education's cash flow model is continually being updated and 

copies of the model with original assumptions were not fully maintained, it 

was not possible to determine the precise effect on subsidy costs of 

changes in interest rates versus other changes. In order to address this 
Appendix II

Objectives, Scope, and Methodology

Page 58 GAO-01-197 FDLP Cost Estimates

question, we assessed the general impact of declining interest rates by 

analyzing the effect of declining borrower rates and discount rates. To 

determine the impact of declining borrower rates and discount rates, we 

requested that Education calculate subsidy costs for four scenarios. We 

analyzed the results of these calculations and discussed with Education 

personnel their procedures for accounting for changes in interest rates in 

the credit subsidy estimates and reestimates. We compared Education's 

procedures with the guidance provided in OMB Circular A-11. 

Question 8 What are the future prospects for the continued negative subsidy for the 

Federal Direct Loan Program?

We analyzed the results from several of the other questions to determine 

what conditions increase or decrease the likelihood for continued negative 

subsidy of FDLP. We analyzed the effect of fee reductions and increased 

consolidations from question 6, the impact of interest rates on subsidy cost 

from question 7, and the result of the sensitivity analysis from question 3. 

Question 9 What data did Education use to project an estimated saving of $4 on every 

$100 of direct student loans, as it reported in November 1999? 

We analyzed Education's November 1999 cost study to get a general 

understanding of the methodology used to develop administrative and 

subsidy cost estimates for FFELP and FDLP. We interviewed Education 

personnel to obtain a more detailed understanding of the methodology and 

data sources used to assign, develop, and project the administrative and 

subsidy cost estimates. We also reviewed spreadsheets and other 

documentation prepared by Education to support its findings. 
Page 59 GAO-01-197 FDLP Cost Estimates

Appendix III

GAO Contacts and Staff Acknowledgments ApendxiI

GAO Contacts Linda M. Calbom, (202) 512-9508

Cornelia M. Ashby, (202) 512-8403

Acknowledgments In addition to those named above, Daniel R. Blair, Marcia L. Carlsen, 

Susan T. Chin, Anh Dang, Cheryl D. Driscoll, Julia B. Duquette, 

Elizabeth M. Kreitzman, Kirsten L. Landeryou, Joel R. Marus, 

Andrew Sherrill, Linda W. Stokes, and Maria Zacharias made key 

contributions to this report.
Page 60 GAO-01-197 FDLP Cost Estimates

Glossary

The following is a group of terms commonly used in credit budgeting and 

accounting. The definitions for many of these terms are equally applicable 

to loan guarantees. However, since FDLP is a direct loan program, 

references to loan guarantees have been omitted.

Administrative Expenses All costs directly related to credit program operations, including: 

(1) activities related to credit extension, loan servicing, write-off, and 

closeout; (2) loan systems development and maintenance, including 

computer costs; (3) all monitoring of credit programs and private lenders 

for compliance with laws and regulations; (4) the cost of operating 

separate offices that make policy decisions for credit programs; (5) the 

cost of collecting delinquent loans; and (6) the proportion of administrative 

expenses shared with noncredit programs.

Assumptions Basic beliefs about the future performance of a loan or group of loans. 

Types of assumptions include the following:

• Cash flow assumptions − all known and/or forecasted information about 

the characteristics and performance of a loan or group of loans. 

Examples include estimates of loan maturity, borrower rate, 

default/delinquency rate, and timing of cash flow events, such as 

defaults and collections on defaulted loans. 

• Model assumptions − determinations of how cash flow assumptions are 

applied through the life of a cohort of loans. For example, determining 

whether the entire estimated amount of defaults should be applied in 

one year or allocated over several years.

Cash Flows Payments or estimates of payments to or from the government over the life 

of a loan or group of loans. For direct loans, these may include: loan 

disbursements, repayments of principal, payments of interest, 

prepayments, fees, penalties, defaults and collections on defaulted loans.

Cohort All loans of a program for which a subsidy appropriation is provided for a 

given fiscal year, even if disbursements occur in subsequent years.
Glossary

Page 61 GAO-01-197 FDLP Cost Estimates

Credit Program Account A budget account into which an appropriation for the funds to finance a 

loan program is made and from which funds are disbursed to a financing 

account for the program.

Discount Rates The collection of interest rates that are used to calculate the present value 

of the cash flows that are estimated over a period of years. For the period 

we reviewed, when calculating the present value of loan subsidy costs, 

agencies were required to use as the discount rate the average annual 

interest rate for marketable U.S. Treasury securities with similar maturities 

to the loan or guarantee.

Financing Account A nonbudgetary account that collects the payments from a credit program 

account and borrowings from Treasury. It includes all cash flows to and 

from the government resulting from loan programs. At least one financing 

account is associated with each credit program account.

Key Assumptions Assumptions that have been established, through sensitivity analysis or 

other means, to be the elements that have a large impact on estimates and 

thus are the most important factors in determining the cost of a loan or 

group of loans.

OMB Credit Subsidy 

Calculator

A computer software program that calculates a subsidy rate based on the 

present value of agency-generated estimates of cash flows to and from the 

government. It also calculates the portions of the subsidy cost attributable 

to defaults, interest, fees, and other subsidy components.

Present Value The worth of the future stream of returns or costs in terms of money paid 

immediately. In calculating present value, prevailing interest rates provide 

the basis for converting future amounts into their “money now” 

equivalents.

Risk Category A subdivision of a cohort of loans into groups of loans that are relatively 

homogeneous in cost, given the facts known at the time of obligation or 

commitment. Risk categories will group all loans obligated or committed 
Glossary

Page 62 GAO-01-197 FDLP Cost Estimates

for a program during the fiscal year that share characteristics predictive of 

defaults and other costs. 

Reestimates Revisions of the subsidy cost estimate of a cohort (or risk category) based 

on information about actual performance of a cohort of loans or estimated 

changes in future cash flows of the cohort.

Subsidy Cost The estimated long-term cost to the government of a direct loan, calculated 

on a net present value basis, excluding administration costs.

(916365) Letr
Ordering Information The first copy of each GAO report is free. Additional copies of 

reports are $2 each. A check or money order should be made out to 

the Superintendent of Documents. VISA and MasterCard credit 

cards are accepted, also.

Orders for 100 or more copies to be mailed to a single address are 

discounted 25 percent.

Orders by mail:

U.S. General Accounting Office

P.O. Box 37050

Washington, DC 20013

Orders by visiting:

Room 1100

700 4th St. NW (corner of 4th and G Sts. NW)

U.S. General Accounting Office

Washington, DC

Orders by phone:

(202) 512-6000

fax: (202) 512-6061

TDD (202) 512-2537

Each day, GAO issues a list of newly available reports and 

testimony. To receive facsimile copies of the daily list or any list 

from the past 30 days, please call (202) 512-6000 using a touchtone 

phone. A recorded menu will provide information on how to obtain 

these lists.

Orders by Internet:

For information on how to access GAO reports on the Internet, 

send an e-mail message with “info” in the body to:

info@www.gao.gov

or visit GAO’s World Wide Web home page at: 

http://www.gao.gov

To Report Fraud, 

Waste, or Abuse in 

Federal Programs

Contact one:

• Web site: http://www.gao.gov/fraudnet/fraudnet.htm

• e-mail: fraudnet@gao.gov

• 1-800-424-5454 (automated answering system)

United States

General Accounting Office

Washington, D.C. 20548-0001

Official Business

Penalty for Private Use $300

Address Correction Requested

Bulk Rate

Postage & Fees Paid

GAO

Permit No. GI00