Department of Education: Key Aspects of the Federal Direct Loan Program's Cost Estimates
Published: 2001-01-12T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Department of Education runs two major federal student loan programs, the William D. Ford Federal Direct Loan Program (FDLP) and the Federal Family Education Loan Program (FFELP). Under FDLP, students or their parents borrow money directly from the federal government through the schools the students attend. Under FFELP, money is borrowed from private lenders, and the federal government guarantees repayment if the borrowers default. GAO investigated concerns about Education's reliance on estimates to project FDLP costs and a lack of historical information on which to base those estimates.
section_title: What GAO Found
paragraphs: GAO found that developing a reasonable estimate of subsidy cost for loan programs is complex. Many assumptions must be taken into account and projections must be made for the life of the loans. Because FDLP's subsidy costs are determined largely by interest rates and interest rate fluctuations cannot be predicted with any certainty, it is unclear whether the current trend in negative subsidy costs for FDLP will continue. In addition, other factors, such as origination fees paid by borrowers, defaults, subsequent collections on defaulted loans and timing of loan repayments, affect the subsidy cost of FDLP. Although Education is able to estimate origination fees close to the actual amounts in the financial system, other key cash flows varied significantly. Also, Education's current model for estimating FDLP subsidy costs does not directly take into account key factors, such as prepayments and consolidations.

section_title: Letter
paragraphs: 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. 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?
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. 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.
subsections: section_title: Overview
paragraphs: 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,  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 analysis 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  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.
section_title: Background
paragraphs: 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, or deferment 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.
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. 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.
Borrowers most commonly repay their FDLP loans using one of four  repayment plans: standard, extended, graduated, or income contingent.  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 value of estimated net cash flows,  excluding administrative costs.
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.
section_title: Questions and Answers
subsections: section_title: Question 1
paragraphs: 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).
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.
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. 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.
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.
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.
section_title: Question 2
paragraphs: Have cash inflows (excluding borrowings from Treasury and borrower  principal repayments) exceeded cash outflows (excluding repayments to  Treasury and loan disbursements)?
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. 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.
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  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.
section_title: Question 3
paragraphs: 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 analysis—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. 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.
subsections: section_title: Key Cash Flow Assumptions
paragraphs: 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 Calculator 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 number 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.
Based on the results of the limited sensitivity analysis, we determined that  seven of the nine cash flow assumptions tested were key. 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. 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.
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.
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  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.
section_title: Sensitivity of Subsidy to Changes in Key Assumptions
paragraphs: 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. 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. 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.
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 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.
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  change in them can have a significant impact on the estimated cost of the  loan program.
section_title: Data Supporting Key Cash Flow Assumptions
paragraphs: Table 6 summarizes the sources of data Education used to support the  seven key cash flow assumptions identified in the sensitivity analysis.
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  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. 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.
section_title: Question 4
paragraphs: 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?
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.
subsections: section_title: Comparing Estimated to Actual Cash Flows
paragraphs: 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,  origination fees, and collections on defaulted loans. 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  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.
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.
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  significant difference between the estimated and actual interest receipts  from borrowers and (2) a key factor in differences in principal receipts.
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.
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.
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.
section_title: Tracking Differences Between Actuals and Estimates
paragraphs: 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,  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.
section_title: Question 5
paragraphs: 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?
In August 1999, Education reduced its origination fees for FDLP student  loans from 4 percent to 3 percent. 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 2001 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 reported 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.
subsections: section_title: Effect of Loan Origination Fee Reduction
paragraphs: 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  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.
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.
section_title: How Education Considered the Fee Reduction in Its Subsidy Costs
paragraphs: 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.
section_title: Question 6
paragraphs: 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  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.
section_title: Question 7
paragraphs: 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.
subsections: section_title: Declining Interest Rates’ Effect on Subsidy Costs
paragraphs: 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 bill 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  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.
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.
section_title: How Education Takes Account of Interest Rate Changes
paragraphs: In order to calculate its subsidy cost estimates, Education uses OMB  economic assumptions 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. 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.
section_title: Question 8
paragraphs: 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  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.
subsections: section_title: Interest Rates’ Effect on the Possibility of a Negative Subsidy
paragraphs: 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.
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.
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.
section_title: Other Factors That Affect Continued Negative Subsidy
paragraphs: 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  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.
section_title: Question 9
paragraphs: 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 mid- session 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. 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.
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.
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). 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.
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.
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  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.
section_title: Conclusions
paragraphs: 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  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.
section_title: Recommendations for Executive Action
paragraphs: 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:  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.
section_title: Agency Comments
paragraphs: 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.
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.
section_title: Estimating Credit Program Costs
paragraphs: 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, 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) 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 value 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  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.
subsections: section_title: Developing Cash Flow Assumptions and Models
paragraphs: 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  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.
section_title: Reestimating Credit Subsidies
paragraphs: 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  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,  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  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.
section_title: Objectives, Scope, and Methodology
paragraphs: 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.
subsections: section_title: Question 1
paragraphs: 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.
section_title: Question 2
paragraphs: 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  and 1999, we verified the actual data to cash collection amounts provided  by Education's financial systems.
section_title: Question 3
paragraphs: 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 Act and requested that  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.
section_title: Question 4
paragraphs: 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  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.
section_title: Question 5
paragraphs: 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.
section_title: Question 6
paragraphs: 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.
section_title: Question 7
paragraphs: 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  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.
section_title: Question 8
paragraphs: 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.
section_title: Question 9
paragraphs: 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.
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: 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.
section_title: Glossary
paragraphs: 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.
subsections: section_title: Ordering Information
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