Credit Programs: Key Agencies Should Better Document Procedures for Estimating Subsidy Costs
Published: 2016-07-13T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Federal direct loans and loan guarantees outstanding have doubled from $1.5 trillion as of September 30, 2008, to $3.0 trillion as of September 30, 2015, as reported in the financial reports of the U.S. government. In light of the growing portfolio of outstanding direct loans and loan guarantees, questions have been raised about how agencies estimate the subsidy cost of credit programs.
GAO was asked to review the process federal agencies use to develop subsidy cost estimates for credit programs. This report examines (1) the key elements federal agencies should consider when developing subsidy cost estimates and (2) the extent to which certain agencies addressed these key elements when estimating the subsidy costs for selected federal credit programs. GAO analyzed budgeting and accounting guidance to identify a list of key elements agencies should consider when estimating subsidy costs and assessed the subsidy cost estimation processes used for three credit programs against these key elements. The three programs were selected based on average loan amounts and/or loan volume.
section_title: What GAO Found
paragraphs: The Federal Credit Reform Act of 1990 requires agencies to estimate the cost to the government of extending or guaranteeing credit. This cost, referred to as subsidy cost, equals the net present value of estimated cash flows from the government (e.g., loan disbursements and claim payments to lenders) minus estimated cash flows to the government (e.g., loan repayments, interest payments, fees, and recoveries on defaulted loans) over the life of the loan, excluding administrative costs. Agencies use established methods and data to estimate the future costs of a program based on what is known today. Based on budgeting and accounting guidance, GAO determined that agencies' estimation processes should include various key elements to help ensure that estimates are supported, reliable, and reasonable. For example, agency management should compare estimated and actual cash flows to identify potential trends. The figure below lists the key elements GAO identified based on relevance to creating credible cost estimates.
To assess how agencies addressed these key elements in their subsidy cost estimation processes, GAO assessed (1) the Department of Agriculture's (USDA) Export Credit Guarantee (GSM-102) Program, (2) the Department of Housing and Urban Development's (HUD) Mutual Mortgage Insurance Fund, and (3) the Department of Education's (Education) William D. Ford Federal Direct Loan Program (Direct Student Loan Program). GAO found that these agencies varied in their implementation of these key elements, as shown below.
While USDA documented the key elements of the estimation process for the GSM-102 program, HUD and Education lacked policies and procedures and adequate documentation for certain other key elements. Until these key elements are fully addressed, HUD and Education have increased the risk that institutional knowledge used in the estimation process may be lost and estimates may not be supported, reliable, and reasonable.
section_title: What GAO Recommends
paragraphs: GAO recommends that HUD and Education develop and document additional procedures related to the subsidy cost estimation process. HUD and Education concurred with GAO's recommendations and described ongoing and planned actions to address them.

section_title: Letter
paragraphs: The federal government uses credit programs that provide direct loans  and loan guarantees as tools to support specific social and public policy  objectives, such as those for housing, education, and small businesses.  The amount of federal credit outstanding has doubled from approximately  $1.5 trillion as of September 30, 2008, to approximately $3.0 trillion as of  September 30, 2015. Federal agencies that provide credit are generally  required to annually estimate the net long-term cost to the government of  extending or guaranteeing credit—referred to as subsidy cost—for each  credit program. These estimated subsidy costs are reported in agencies’  annual budgets and financial statements. Agencies use established  methods and data to estimate the future costs of a program based on  what is known today. The management of a cost estimate involves  updating the estimate with actual data as they become available, revising  the estimate to reflect program changes, and analyzing differences  between estimated and actual costs to identify any needed revisions to  the estimation process. Reliable cost estimates are needed for the  management and budgeting of credit programs and to support  congressional oversight.
In light of the growing portfolio of outstanding direct loans and loan  guarantees, you asked us to examine the budgetary treatment of the cost  of federal credit programs and how federal agencies estimate subsidy  costs for credit programs. We have addressed these issues in two  reports. In January 2016, we issued a report that (1) analyzed  government-wide subsidy cost reestimates for direct loans and loan  guarantees approved from fiscal years 2001 through 2014 and (2)  explained implications of estimating credit program costs for the budget  under the fair value approach rather than the current method under the  Federal Credit Reform Act of 1990 (FCRA) for calculating subsidy costs.  This report (1) describes the key elements federal agencies should  consider when developing subsidy cost estimates based on relevant  guidance and (2) evaluates the extent to which certain agencies  addressed these key elements when estimating subsidy costs for  selected federal credit programs.
For this report, we reviewed budgeting guidance, accounting standards  and principles, and publications of best practices to identify a list of key  elements that federal agencies should consider when developing and  managing subsidy cost estimates. We determined the key elements  based on their relevance to creating credible cost estimates. We used this  list of key elements to assess the extent to which (1) the Department of  Agriculture’s (USDA) Commodity Credit Corporation (CCC) Export Credit  Guarantee (GSM-102) Program, (2) the Department of Housing and  Urban Development’s (HUD) Federal Housing Administration’s (FHA)  Mutual Mortgage Insurance (MMI) Fund, and (3) the Department of  Education’s (Education) William D. Ford Federal Direct Loan Program  (Direct Student Loan Program) addressed these elements in estimating  the subsidy costs for the selected credit programs. We selected the Direct  Student Loan Program and the MMI Fund because these programs  represent the largest federal direct loan and loan guarantee programs,  respectively. These two programs can be characterized as having a high  volume of loans with relatively lower average loan amounts compared to  other federal credit programs. To include a different type of credit  program in our evaluation, we also selected the GSM-102 program, which  can be characterized as having a lower volume of loans and larger  average loan amounts. For these three programs, we evaluated the  processes used by CCC, FHA, and Education to develop subsidy cost  estimates and compared those processes to our list of key elements  agencies should consider. We did not evaluate the reasonableness of  subsidy cost estimates, reestimates, or the data and assumptions used to  calculate them. See appendix I for additional details on our scope and  methodology.
We conducted this performance audit from June 2014 to July 2016 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: Federal credit programs provide assistance to borrowers through two  principal methods: direct loans and loan guarantees. Direct loans are a  disbursement of funds by the government to a nonfederal borrower under  a contract that requires the repayment of such funds with or without  interest. Loan guarantees are any guarantees, insurance, or other  pledges with respect to the payment of all or a part of the principal or  interest on any debt obligation of a nonfederal borrower to a nonfederal  lender.
As of September 30, 2015, 21 federal agencies reported that they had  direct loans or loan guarantees outstanding. As shown in figure 1,  Education (largely through its Direct Student Loan Program) and HUD  (largely through its single-family mortgage guarantee program or the MMI  Fund) held the largest share of federal direct loans and loan guarantees  outstanding, respectively.
subsections: section_title: The Federal Credit Reform Act of 1990
paragraphs: Twenty-five years ago, the enactment of FCRA changed the method used  to budget for the cost of federal credit programs. Before fiscal year 1992,  when FCRA took effect, the cost of credit programs was recorded in the  budget on a cash basis (the expected amount of cash paid out minus the  cash received in a given year). As a result, the budget cost associated  with a loan guarantee was not recorded until a default occurred, which  may have been many years after the guarantee was made. Further, direct  loans appeared to cost the same as grants because the total amount of a  loan was recorded as a cost when the loan was made and loan  repayments were not recorded until the year received. Both were  inaccurate and provided policymakers with distorted information for  comparing credit programs to noncredit programs and to each other. This  also created a bias in favor of loan guarantees over direct loans because  loan guarantees appeared to be less expensive than direct loans,  regardless of the actual lifetime cost to the government.
FCRA was enacted with the intent of improving the accuracy of the cost  of federal credit programs reported in the budget by requiring agencies to  measure the government’s net long-term cost of federal credit programs  to permit better cost comparisons both among credit programs and  between credit and noncredit programs. The policies enacted under  FCRA, sometimes referred to simply as credit reform, recognized that the  actual cost of a direct loan or loan guarantee is not captured by its cash  flows in any one year, but rather is the net present value—worth in terms  of money paid immediately—of its cash flows over the life of the loan.  Therefore, FCRA specified an approach using estimates of expected  cash flows, including future loan repayments and defaults as elements of  the cost to be recorded in the budget.
section_title: Subsidy Cost Estimates and Reestimates
paragraphs: FCRA requires agencies to estimate the net long-term cost to the  government of extending or guaranteeing credit. This cost, referred to as  subsidy cost, equals the net present value of estimated cash flows from  the government minus estimated cash flows to the government, over the  life of the loan and excluding administrative costs. This approach puts  direct loans and loan guarantees on an equal footing in terms of cost in  the federal budget and permits the costs of credit programs to be  compared with each other and with the costs of noncredit programs.  Figure 2 illustrates the types of cash flows that affect the subsidy costs for  direct loans and loan guarantees. If the present value of estimated cash  outflows exceeds cash inflows, there is a subsidy cost. If the present  value of estimated cash inflows exceeds cash outflows, there is a  negative subsidy cost, referred to as subsidy income.
The subsidy cost represents the net present value cost of making or  guaranteeing new loans and is included in the President’s Budget for the  year the direct loan or loan guarantee is made. FCRA requires that  agencies have budget authority to cover a program’s subsidy cost to the  government in advance—before new direct loan obligations are incurred  and new loan guarantee commitments are made. The data used for  budgetary subsidy cost estimates are generally updated—or  reestimated—annually after the end of the fiscal year to reflect actual loan  performance and to incorporate any changes in assumptions about future  loan performance. Reestimates that increase subsidy costs are referred  to as upward reestimates (an agency would need additional funds), while  reestimates that decrease subsidy costs are referred to as downward  reestimates (an agency would return funds). Agencies do not need to  request additional appropriations to cover upward reestimates because  FCRA provides permanent indefinite budget authority for this purpose.
section_title: Agencies Use Cash Flow Models to Estimate Subsidy Costs
paragraphs: To implement FCRA and calculate subsidy costs, agencies estimate the  expected cash outflows and inflows over the life of the loans for each  cohort of direct loans obligated or loan guarantees committed in the  cohort year. The efforts to make reasonable subsidy cost estimates  begin with establishing and using reliable records of historical credit  performance data and taking into consideration current and forecasted  economic conditions. Agency management is responsible for  accumulating relevant, sufficient, and reliable data on which to base the  estimates. Further, according to the primary accounting standard for  direct loans and loan guarantees, subsidy cost estimates should be  based on a systematic methodology to project expected cash flows into  the future. To accomplish this task, an agency develops a cash flow  model, which is a mathematical model that generally uses historical  information and various assumptions related to future loan performance,  including loan repayments, prepayments, defaults, recoveries, and the  timing of these events. Such a cash flow model, which is based on sound  economic, financial, and statistical theory, identifies factors that affect  loan performance. In addition to using historical data, other relevant  factors may be considered by agencies when estimating future loan  performance. These factors may include (1) economic conditions that  may affect loan performance, (2) financial and other relevant  characteristics of borrowers, (3) the value of the collateral to loan  balance, (4) changes in recoverable value of collateral, and (5) newly  developed events that would affect loan performance. In addition, 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, as well as informed opinion. Various budgeting and  accounting guidance related to estimating subsidy costs requires  agencies to establish internal controls over the calculations, including  establishing and documenting policies and procedures and maintaining  supporting documentation for subsidy cost estimates.
section_title: Key Elements Agencies Should Consider When Preparing Subsidy Cost Estimates
paragraphs: Agencies develop subsidy cost estimates based on relevant budgeting  and accounting guidance. FCRA assigned to the Office of Management  and Budget (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 OMB’s written guidelines. These  guidelines are primarily contained in OMB Circular No. A-11, Preparation,  Submission, and Execution of the Budget. Further, the Federal  Accounting Standards Advisory Board (FASAB) developed the primary  accounting standard for federal credit programs, Statement of Federal  Financial Accounting Standards (SFFAS) No. 2, Accounting for Direct  Loans and Loan Guarantees, which became effective in fiscal year 1994.  This standard established financial accounting guidance consistent with  FCRA for estimating the cost of direct loan and loan guarantee programs,  and for recording direct loans receivable and the liability for loan  guarantees for financial reporting purposes.
While OMB Circular No. A-11 and SFFAS No. 2 provide general guidance  for agencies to develop subsidy cost estimates, detailed guidance on the  preparation of subsidy cost estimates is contained in FASAB’s Accounting  and Auditing Policy Committee’s Technical Release 6 Preparing  Estimates for Direct Loan and Loan Guarantee Subsidies under the  Federal Credit Reform Act. This technical release provides detailed  guidance and specific practices that if fully implemented by federal  agencies, should enhance their ability to reasonably estimate credit  program costs. In addition, GAO’s Cost Estimating and Assessment  Guide: Best Practices for Developing and Managing Capital Program  Costs provides detailed guidance on developing cost estimates. We  identified the following practices discussed in Technical Release 6 and  the cost estimating guide as the key elements of the subsidy cost  estimation process based on relevance to creating credible cost  estimates:
Historical data validation: Management should accumulate  sufficient, relevant, and reliable supporting data on which to base  cash flow projections, such as data on prepayments, defaults, and  recoveries. Subsidy cost estimates should be based on the best  available data at the time the estimates are made.
Informed opinion documentation: In certain limited instances, when  relevant historical data, modeling capabilities, or both are not  available, informed opinion may be used to support cash flow  projections. When informed opinion is used, management should  document the expert’s qualifications. In addition, the basis for the  stated opinion must be articulated and documented in detail, including  an explanation for why the particular projection is appropriate for the  program.
Cash flow assumption documentation: Documentation must be  developed to support the assumptions used by agencies in the  subsidy cost calculations, including the data sources and calculation  methods. Assumptions should also be coordinated between program  and accounting offices.
Cash flow model documentation: Management should ensure that  its cash flow models used to estimate subsidy cost estimates are well  organized; documented; and, to reduce the chance of errors, require  minimal manual data entry. Documentation should include the  rationale for using the specific model; the mechanics of the model,  including how to use and update the model and formulas and other  mathematical functions within the model; and sources of supporting  data. Management should also document the controls over the model,  including management review and approval of the model. Often,  because of the complexity of cash flow models, management will hire  a private firm to conduct an independent verification and validation of  the model, which entails ensuring that the model’s calculations are  accurate and consistent with the model documentation.
Program design comparison: Based on the laws and regulations  that govern the credit program, management should document a  comparison of the cash flow model and assumptions to relevant  program design factors, such as fees, grace periods, and maximum  loan amounts. This documentation will help management ensure that  credit subsidy estimates are prepared consistent with the terms and  conditions of the program.
Analysis of estimated cash flows: Management should conduct  periodic comparisons of estimated loan performance to actual cash  flows in the accounting system. This comparison allows agencies to  identify and research significant differences and determine whether  the cash flow model or assumptions related to expected future loan  performance need to be revised. Further, if management identifies  consistent trends in under- or overestimates of subsidy costs, such  trends should be investigated and explained.
Sensitivity analysis: Management should perform sensitivity  analyses to identify which cash flow assumptions—such as defaults,  recoveries, or prepayments—have the greatest impact on the cost of  the credit program. Knowledge of these key assumptions provides  management with the ability to monitor the economic trends that most  affect the program’s performance. These analyses also allow  agencies to more efficiently focus their efforts on documenting the  support for the key assumptions.
Policies and procedures for estimating subsidy costs:  Management should establish and document policies and procedures  for calculating subsidy cost estimates, including required supporting  documentation and a formal review and approval process. In addition,  preparing reliable and timely direct loan and loan guarantee subsidy  cost estimates must be a joint effort between the budget, accounting,  and program offices at each agency. These offices should work  together to ensure that the procedures and internal controls are  implemented and operating as designed. Further, documented  policies and procedures are important internal controls that are  designed to help ensure continuity when there is employee turnover  and to calculate reliable, reasonable, and well-supported cost  estimates.
In addition, Standards for Internal Control in the Federal Government  requires controls and transactions to be clearly documented and  documentation to be readily available for examination. Documentation is  necessary and required to demonstrate the design, implementation, and  operating effectiveness of an entity’s internal control system.  Documentation also provides a means to retain organizational knowledge  and mitigate the risk of having knowledge limited to a few personnel, as  well as a means to communicate as needed to external parties, such as  external auditors. Further, in implementing internal controls, management  is responsible for developing the detailed policies, procedures, and  practices to fit their agency’s operations and to ensure that they are built  into and an integral part of operations.
section_title: Agencies Addressed Several Key Elements in Their Subsidy Cost Estimation Processes, but FHA and Education Lacked Adequate Documentation Supporting Certain Processes
paragraphs: Based on our review of the subsidy cost estimation processes for USDA’s  Credit Commodity Corporation’s (CCC) Export Credit Guarantee (GSM- 102) Program, HUD’s Federal Housing Administration’s (FHA) Mutual  Mortgage Insurance (MMI) Fund, and Education’s William D. Ford  Federal Direct Loan Program (Direct Student Loan Program), we  determined that while CCC addressed all key elements of the estimation  process, FHA and Education lacked comprehensive documented policies  and procedures for determining subsidy cost estimates and did not  maintain adequate documentation supporting their implementation of  other key elements of the estimation process. Figure 3 illustrates the key  elements of the estimation process and the extent to which agencies  addressed these key elements for the programs we reviewed.
subsections: section_title: CCC Documented the Key Elements in Preparing Subsidy Cost Estimates for the GSM-102 Program
paragraphs: CCC designed and documented procedures for each of the key elements  in its subsidy cost estimation process for the GSM-102 program. The  GSM-102 program is intended to promote exports of U.S. agricultural  commodities by providing export credit guarantees. As of fiscal year  2015, CCC’s GSM-102 program had approximately $2.9 billion in  outstanding loan guarantees. In the event that CCC pays a claim under  the loan guarantee program, CCC assumes the debt and treats it as a  loan receivable for accounting and collection purposes. As of fiscal year  2015, the GSM-102 program had approximately $682 million of  outstanding loans receivable. to expand market opportunities for U.S.  agricultural exporters and to assist long-term  market development for U.S. agricultural  commodity exports. Through the use of export  credit guarantees, CCC encourages U.S.  private sector financing of foreign purchases  of U.S. agricultural commodities on credit  terms. The export credit guarantee issued  under the GSM-102 program is an agreement  by CCC to pay the exporter or the U.S.  financial institution specified amounts of  principal and interest in case of default by the  foreign financial institution for the export sale  covered by the export credit guarantee. Under  the GSM-102 program, maximum repayment  terms may vary based on risk of default, as  determined by CCC. The program operates in  a manner intended not to interfere with  markets for cash sales and is targeted toward  those countries that have sufficient financial  strength so that foreign exchange will be  available for scheduled payments.
To estimate the subsidy cost of the GSM-102 program, CCC developed  an econometric cash flow model that utilizes foreign economic indicators  that influence loan performance, including commitment amounts, upfront  fees, claim payments, write-offs, recoveries, and rescheduling. Most of  the key elements of the subsidy cost estimation process for the GSM-102  program were documented by CCC in one of three documents: (1)  standard operating procedures, (2) cash flow model documentation, and  (3) a cash flow model user guide. Table 1 describes the design and  documentation of the subsidy cost estimation process for CCC’s GSM- 102 program in relation to the key elements we identified.
We reviewed the supporting documentation that CCC provided related to  the key elements of the subsidy cost estimation process and found that  CCC adequately addressed the key elements. Adequately addressing the  key elements helps an agency ensure that subsidy cost estimates are  supported, reliable, and reasonable.
section_title: FHA Addressed Several Key Elements in Preparing Subsidy Cost Estimates for the MMI Fund; However, Documentation Was Incomplete
paragraphs: FHA addressed several key elements of the subsidy cost estimation  process for the MMI Fund, evidenced by documentation of its cash flow  model and assumptions. However, it lacked documented policies and  procedures over the subsidy cost estimation process and documentation  of other key elements of the process. FHA through the MMI Fund insures  private lenders against losses from defaults on single-family forward  mortgages that meet FHA criteria. As of September 30, 2015, FHA had  approximately $1.1 trillion in forward mortgage loan guarantees  outstanding.
Department of Housing and Urban  Development (HUD), Federal Housing  Administration (FHA), Mutual Mortgage  Insurance (MMI) Fund  FHA has played a particularly large role  among minority, lower-income, and first-time  homebuyers and promotes stability in the  market by providing mortgage insurance in  areas that may be underserved by the private  sector or are experiencing economic  downturns. Homebuyers may obtain FHA- insured mortgages from FHA-approved  lenders to purchase new or existing properties  with one to four housing units (including  condominium units) with low down payments  or to refinance existing debt on such  properties. HUD insures loans made by  private financial institutions. By insuring  lenders against loss, FHA encourages them to  invest capital in the home mortgage market. In  addition to these typical loans, FHA also  insures single-family reverse mortgages.  Reverse mortgages permit persons 62 years  and older the ability to convert some of the  equity in their primary residences into monthly  streams of income or lines of credit.
To estimate the subsidy cost of the MMI Fund, the federal government’s  largest loan guarantee program, FHA developed an econometric cash  flow model that is sensitive to, among other things, house price  appreciation and unemployment rates, which affect estimates associated  with borrower repayments or default. The cash flow model has four  modules that forecast (1) the size of future loan cohorts, (2) loan  performance, (3) the impact of loss mitigation efforts, and (4) the severity  of losses for loans that are expected to result in insurance claims. As its  final output, the cash flow model produces the expected nominal future  cash flows, including insurance premiums, refunds, claim payments, and  recoveries using inputs from the four modules. Table 2 describes the  design and documentation of the subsidy cost estimation process for  FHA’s MMI Fund in relation to the key elements we identified.
We reviewed the supporting documentation that FHA provided related to  its subsidy cost estimates for the MMI Fund and found that while FHA  addressed several key elements of the subsidy cost estimation process, it  lacked documentation for three key elements that would help ensure  proper implementation of its processes. Specifically, as noted in table 2,  we found that FHA did not have comprehensive, documented, and  approved policies and procedures over the subsidy cost estimation  process. We also found that FHA did not (1) fully document procedures to  help ensure that its subsidy cost estimates are consistent with the terms  and conditions of the MMI Fund or (2) document procedures to require a  sensitivity analysis that identifies key cash flow assumptions. FHA  explained that in February 2016, it awarded a new contract that includes  preparing estimates of subsidy costs and also requires documentation of  policies and procedures over the subsidy cost estimation process for  FHA. In addition, FHA officials indicated that they are in the process of  developing a solicitation to have a contractor perform an independent  verification and validation of its cash flow model to help ensure that the  model’s calculations are accurate and consistent with the model  documentation. Completing this documentation of the key elements of the  subsidy cost estimation process will help management oversee the  program as required by internal control standards and help FHA support  its subsidy cost estimates.
section_title: Education Addressed Some Key Elements in Preparing Subsidy Cost Estimates for Its Direct Student Loan Program; However, Documentation Was Incomplete
paragraphs: While Education addressed some of the key elements of the subsidy cost  estimation process for the Direct Student Loan Program, it did not provide  adequate documentation of (1) the process to validate historical data  used in subsidy cost estimates, (2) cash flow assumptions and the cash  flow model used to estimate subsidy costs, (3) its process to analyze  estimated cash flows for reasonableness, and (4) the process to perform  sensitivity analysis. Further, Education was unable to provide  documentation of (1) overall policies and procedures for estimating  subsidy costs, (2) the method used to document informed opinion used in  the subsidy cost estimation process, and (3) the process to help ensure  that estimated cash flows are consistent with the design of the program.  Education, through its Direct Student Loan Program, provides qualified  students and their parents with loans to obtain postsecondary education.  As of September 30, 2015, Education’s Direct Student Loan Program had  approximately $845.1 billion in outstanding loans.
Department of Education (Education),  William D. Ford Federal Direct Loan  Program (Direct Student Loan Program)  Education’s Direct Student Loan Program  provides students and their parents loans to  obtain postsecondary education. Loan  origination is done through postsecondary  institutions, but loan servicing is handled by  Education through private sector contractors.  The Direct Student Loan program features  four types of loans: (1) Stafford Loans, which  are subsidized, low-interest loans based on  financial need and are only available to  undergraduate students; (2) Unsubsidized  Stafford Loans, which have a fixed interest  rate for undergraduate borrowers and a  different fixed interest rate for graduate and  professional borrowers; (3) Parent Loans for  Undergraduate Students Loans, which are  available to parents of dependent  undergraduate students and to graduate and  professional students; and (4) Consolidation  Loans, which allow borrowers with multiple  student loans who meet certain criteria to  combine their loans and extend their  repayment schedules. Under the Direct  Student Loan Program, interest rates are  determined based on statute, there are  several repayment plans available to  borrowers, and loan terms may extend up to  30 years.
To estimate the subsidy costs of the Direct Student Loan Program, the  federal government’s largest direct loan program, Education estimates  cash flows based on a variety of loan characteristics. For example, the  cash flow model estimates cash flows based on the loan type (i.e.,  subsidized or unsubsidized), the repayment plan (i.e., standard,  extended, graduated, and income-driven repayments), and the type of  school the student attends (i.e., trade school, community college, or 4- year university). Each of these factors influences loan performance and  complicates the subsidy cost estimation process for the program. Table 3  describes how the subsidy cost estimation process for Education’s Direct  Student Loan Program compares to the key elements we identified.
We reviewed supporting documentation and interviewed Education  officials responsible for preparing and reviewing subsidy cost estimates  and found that while Education addressed some of the key elements in its  subsidy cost estimation process, it lacked adequate documentation of  these key elements that would help to ensure proper implementation.  Further, as noted in table 3, we found that Education did not have  documented and approved policies and procedures for its Direct Student  Loan Program subsidy cost estimation process. Officials stated that while  it might be helpful to document the roles and responsibilities of those  involved in the subsidy cost estimation process, they believed that the  process was too complicated to be documented in policies and  procedures. Without documented policies and procedures for the overall  subsidy cost estimation process, the other key elements of the process  might not be performed consistently or at all or may not be adequately  documented, as evidenced by Education being unable to provide  adequate documentation for several of the other key elements of the  process that we requested.
In addition, by not having thoroughly documented procedures for the  subsidy cost estimation process, Education is at increased risk of  potential errors in its cash flow calculations. For example, during our  review Education officials stated that they were aware of challenges in the  Direct Student Loan Program’s calculated subsidy cost estimates and  therefore had to manually adjust the estimated cash flows before  submitting reestimates for the 2016 President’s Budget. Officials also  stated that in part because of these challenges, Education has entered  into an interagency agreement with the Department of the Treasury to  improve the Direct Student Loan Program’s cash flow model with a more  comprehensive loan-level model. Education officials stated that the  subsidy cost estimation process involves a balance between limited staff  resources and the effective use of those resources when determining the  extent of supporting documentation to be prepared. However, without a  full set of management-approved procedures for the estimation  processes, the institutional knowledge that Education relies on to  estimate the subsidy cost for the Direct Student Loan Program could be  at risk of loss. Completing this documentation of the key elements of the  subsidy cost estimation process will help management oversee the  program as required by internal control standards and help Education  support its subsidy cost estimates.
section_title: Conclusions
paragraphs: While CCC adequately documented the key elements of the subsidy cost  estimation process for the GSM-102 program, FHA and Education lacked  overall policies and procedures over the subsidy cost estimation process  that address management reviews and approvals and did not maintain  adequate supporting documentation for certain other key elements of the  subsidy cost estimation process for the MMI Fund and Direct Student  Loan Program, respectively. Without policies and procedures and  thorough documentation of the other key elements of the subsidy cost  estimation process, FHA and Education have increased the risk that their  institutional knowledge may be lost; that subsidy cost estimates might not  be consistently prepared or documented; and that the resulting estimates  may not be supported, reliable, and reasonable. Further, if certain key  elements are not being performed, FHA and Education could miss  opportunities to validate or improve their subsidy cost estimates, which in  turn could provide less reliable information to external parties, such as  Congress or auditors.
section_title: Recommendations for Executive Action
paragraphs: To help ensure that subsidy cost estimates for the MMI Fund are  supported, reliable, and reasonable, we recommend that the Secretary of  Housing and Urban Development direct the Principal Deputy Assistant  Secretary for the Office of Housing to take the following action:
Develop detailed policies and procedures over the subsidy cost  estimation process that address, at a minimum, the documentation  that should be prepared and maintained to support subsidy cost  estimates and the process to document management review and  approval of subsidy costs estimates.
To help ensure that subsidy cost estimates for the Direct Student Loan  Program are supported, reliable, and reasonable, we recommend that the  Secretary of Education direct the Assistant Secretary for the Office of  Planning, Evaluation and Policy Development to take the following three  actions:
Develop detailed policies and procedures over the subsidy cost  estimation process that address, at a minimum, the documentation  that should be prepared and maintained to support subsidy cost  estimates and the process to document management review and  approval of subsidy cost estimates.
Develop detailed documentation of the cash flow model used to  estimate subsidy costs, including the rationale for model calculations,  all formulas and assumptions used in the model, data sources, the  process to update and document changes to the model, and the  process to document management review and approval of the model,  which may be based on an independent verification and validation of  the model to ensure that calculations are accurate and consistent with  the model documentation.
Document the procedures and results of such procedures used to  develop or support key elements of the subsidy cost estimation  process, addressing at a minimum (1) the reliability of historical data,  (2) the rationale for informed opinion when applicable, (3) the  methods used to calculate cash flow assumptions, (4) the process to  ensure that subsidy cost estimates are consistent with the terms and  conditions of the program, (5) the process to assess estimated cash  flows for reasonableness, and (6) the process used to perform  sensitivity analysis.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to USDA, HUD, and Education for their  review and comment. Our report did not include recommendations to  USDA, and USDA did not have any comments. In written comments from  HUD and Education, which are summarized below and reprinted in  appendixes II and III, respectively, both agencies concurred with our  recommendations and provided information on their actions planned or  under way to address them. HUD also provided technical comments  which we incorporated as appropriate.
In response to our recommendation to HUD that it develop detailed  policies and procedures over the subsidy cost estimation process, HUD  said that a new contract was issued that will address documentation of  the MMI cash flow model and the subsidy cost estimation process. HUD  also said that it was in the process of developing a solicitation for a  contractor to perform an independent verification and validation of the  MMI cash flow model. HUD stated that completing this documentation of  the subsidy cost estimation process will help management oversee the  program as required by internal control standards and help support its  subsidy cost estimates.
In response to our recommendations to Education, the department said  that it is committed to ensuring that its subsidy cost estimates are  adequately documented. Regarding our first recommendation that  Education develop detailed policies and procedures over the subsidy cost  estimation process, Education said that it has begun drafting more  detailed policies and procedures and hopes to complete this  documentation in a matter of months. Regarding our second  recommendation that Education develop detailed documentation of its  cash flow model used to estimate subsidy costs, Education said that it will  update its model documentation and has invested staff and resources into  developing a new cash flow model to estimate subsidy costs. Education  also said that detailed documentation of this new cash flow model will be  prepared before the model becomes operational. Regarding our third  recommendation that Education document the procedures and results of  such procedures used to develop or support key elements of the subsidy  cost estimation process, Education said that the detailed policies and  procedures developed in response to our first recommendation will  address these key elements.
These HUD and Education actions, if implemented effectively, would  address our recommendations.
We are sending copies of this report to the Secretary of Agriculture, the  Secretary of Housing and Urban Development, the Secretary of  Education, and other interested parties. In addition, the report is available  at no charge on the GAO website at http://www.gao.gov.
If you or your staff have any questions about this report, please contact  me at (202) 512-9377 or clarkce@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. GAO staff members who made key contributions to  this report are listed in appendix IV.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: To identify a list of key elements federal agencies should consider when  developing subsidy cost estimates, we reviewed existing guidance and  best practices related to budgeting and accounting for subsidy cost  estimates. This guidance included the Office of Management and  Budget’s (OMB) Circular No. A-11, Preparation, Submission, and  Execution of the Budget; OMB Circular No. A-129, Policies for Federal  Credit Programs and Non-Tax Receivables; the Federal Accounting  Standards Advisory Board’s (FASAB) Statement of Federal Financial  Accounting Standards No. 2, Accounting for Direct Loans and Loan  Guarantees; the Credit Reform Task Force’s issue paper Model Credit  Program Methods and Documentation for Estimating Subsidy Rates and  the Model Information Store; FASAB’s Accounting and Auditing Policy  Committee’s Technical Release 6 Preparing Estimates for Direct Loan  and Loan Guarantee Subsidies under the Federal Credit Reform Act; and  our Cost Estimating and Assessment Guide: Best Practices for  Developing and Managing Capital Program Costs. Based on our review  of the guidance and best practices, we developed a list of key elements  that agencies should consider when preparing subsidy cost estimates.
To assess the extent to which certain federal agencies addressed the key  elements when estimating the subsidy cost of federal credit programs, we  selected three federal credit programs: (1) the Department of Agriculture’s  Commodity Credit Corporation (CCC) Export Credit Guarantee (GSM- 102) Program, (2) the Department of Housing and Urban Development’s  Federal Housing Administration’s (FHA) Mutual Mortgage Insurance  (MMI) Fund, and (3) the Department of Education’s (Education) William  D. Ford Federal Direct Loan Program (Direct Student Loan Program). We  selected the Direct Student Loan Program and the MMI Fund because  these programs represented the largest federal direct loan and loan  guarantee programs, respectively. These two programs can be  characterized as a high volume of loans with relatively lower average loan  amounts compared to other federal credit programs. To include a different  type of credit program in our evaluation, we also selected the GSM-102  program, which can be characterized as a low volume of loans and  significantly larger average loan amounts.
We met with CCC, FHA, and Education officials responsible for preparing  and approving subsidy cost estimates to discuss the subsidy cost  estimation process for the programs we selected. We requested and  reviewed supporting documentation related to the key elements of the  subsidy cost estimation process. We also reviewed the fiscal year 2015  annual financial statements and related budget information for CCC, FHA,  and Education to obtain background information related to the programs  included in our review. We did not evaluate the reasonableness of  subsidy cost estimates, reestimates, or the data and assumptions used to  calculate them.
We conducted this performance audit from June 2014 to July 2016 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Appendix II: Comments from the Department of Housing and Urban Development
section_title: Appendix III: Comments from the Department of Education
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Marcia Carlsen (Assistant  Director), Steven Westley (Assistant Director), Natasha Guerra, Cole  Haase, Karen Jarzynka-Hernandez, Jason Kelly, Jason Kirwan, Rebecca  Perkins, and Monasha Thompson made key contributions to this report.
section_title: Related GAO Products
paragraphs: Credit Reform: Current Method to Estimate Credit Subsidy Costs Is More  Appropriate for Budget Estimates Than a Fair Value Approach.  GAO-16-41. Washington, D.C.: January 29, 2016.
Rural Housing Service: Progress on GAO Recommendations and  Preliminary Observations on Loan Guarantee Risk Management.  GAO-15-625T. Washington, D.C.: May 19, 2015.
Mortgage Financing: FHA’s $7 Billion Reestimate Reflects Higher Claims  and Changing Loan and Performance Estimates. GAO-05-875.  Washington, D.C.: September 2, 2005.
Mortgage Financing: Actions Needed to Help FHA Manage Risks from  New Mortgage Loan Products. GAO-05-194. Washington, D.C.: February  11, 2005.
Export-Import Bank: OMB’s Method for Estimating Bank’s Loss Rates  Involves Challenges and Lacks Transparency. GAO-04-531. Washington,  D.C.: September 30, 2004.
Department of Education’s Federal Direct Loan Program: Status of  Recommendations to Improve Cost Estimates and Presentation of  Updated Cash Flow Information. GAO-04-567R. Washington, D.C.:  March 29, 2004.
Department of Education: Key Aspects of the Federal Direct Loan  Program’s Cost Estimates. GAO-01-197. Washington, D.C.: January 12,  2001.
Credit Reform: Key Credit Agencies Had Difficulty Making Reasonable  Loan Program Cost Estimates. GAO/AIMD-99-31. Washington, D.C.:  January 29, 1999.
Credit Reform: Greater Effort Needed to Overcome Persistent Cost  Estimation Problems. GAO/AIMD-98-14. Washington, D.C.: March 30,  1998.