Federal Family Education Loan Program: More Oversight Is Needed for Schools That Are Lenders
Published: 2005-01-24T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In fiscal year 2004, lenders made about $65 billion in loans through the Federal Family Education Loan Program (FFELP) to assist students in paying for postsecondary education. The Higher Education Act (HEA), which authorizes FFELP, broadly defined eligible lenders--including schools. The Department of Education's (Education) Office of Federal Student Aid (FSA) is responsible for ensuring that lenders comply with FFELP laws and regulations. Recently, schools have become increasingly interested in becoming lenders, and this has raised concerns about whether it is appropriate for schools to become lenders given that they both determine students' eligibility for loans and in some cases set the price of attendance. In light of these concerns we determined (1) the extent to which schools have participated as FFELP lenders and their characteristics, (2) how schools have structured lending operations and benefits for borrowers and schools, and (3) statutory and regulatory safeguards designed to protect taxpayers' and borrowers' interests.
section_title: What GAO Found
paragraphs: Between school years 1993-1994 and 2003-2004, lending by schools has increased significantly from 22 school lenders disbursing about $155 million to 64 schools disbursing $1.5 billion in FFELP loans. Several schools we interviewed reported that a primary reason to become a FFELP lender was to generate more revenue for the school. About 80 percent of school lenders in school year 2003-2004 were private nonprofit schools, and almost all of them had graduate and professional programs in medicine, law, or business. Most school lenders have contracted with other FFELP organizations to administer their loan programs and subsequently have sold their loans to earn revenue, but school lenders differed in terms of how they financed the loans made and when they sold their loans. About a third of the school lenders we interviewed used their own money to finance the loans they made, while the others obtained lines of credit from a bank or secondary market lender, in some cases from the same organization that eventually purchased the loans disbursed by the school lender. Most schools we interviewed reported using or planning to use revenues earned from the sale of loans to lower student borrowing costs or provide need-based aid. A number of statutory and regulatory provisions applicable to all lenders and schools, and some applicable only to school lenders, exist to safeguard the interests of taxpayers and borrowers. FSA, however, has little information about how school lenders' have complied with FFELP regulations. Under the HEA, FFELP lenders that originate or hold more than $5 million in FFELP loans must submit annually audited financial statements and compliance audits. In October 2004, FSA discovered that 10 of 29 school lenders required to submit an audit for fiscal year 2002 had not done so. Moreover, FSA has not conducted program reviews of school lenders. However, during the course of our review, three regional offices asked 31 school lenders about their compliance with the regulation pertaining to the use of interest income and special allowance payments for need-based grants.

section_title: Letter
paragraphs: The Higher Education Act (HEA) of 1965, as amended, established the  Federal Family Education Loan Program (FFELP), which provided about $65 billion in student loans in fiscal year 2004 and is the largest source of federal financial aid for students and their families. A number of for-profit commercial, nonprofit, and public agencies are involved in the program,  including originating lenders, secondary markets, postsecondary  institutions (schools), and the Department of Education (Education).  Commercial and nonprofit lenders—such as banks and state-designated  agencies—provide loan capital, and the federal government guarantees  these loans against substantially all loss through borrower default. Originating lenders often sell their loans to secondary markets, thereby  obtaining additional capital to make new loans and receiving premium  revenues—payments from loan buyers that are calculated as a percentage  of the face value of the loans sold. Lenders that hold loans receive interest income paid by borrowers and in some cases special allowance payments  from the federal government for the loans they hold. Schools assess  students’ levels of financial need, certify borrower eligibility for loans, and disburse loan proceeds to students. Education’s Office of Federal Student Aid (FSA) is responsible for overall program administration and ensuring  compliance with laws and regulations.
When FFELP was created, in 1965, Congress broadly defined eligible  lenders—including schools—to ensure that students would be able to locate a lender. Schools that are FFELP lenders primarily make loans to  graduate students because of statutory limitations on lending to  undergraduates. As we and various news media have reported, schools,  including those that have participated in the federal government’s other  major student loan program—the William D. Ford Direct Student Loan  Program (FDLP), created in 1993—are becoming increasingly interested in  entering the student loan business as lenders. The possibility of an  increasing number of schools becoming FFELP lenders and receiving  revenues from the loans they make has raised concerns. Specifically,  questions have been raised about whether it is appropriate for schools to  become lenders, given that they both determine students’ eligibility for  loans and in some cases set the price of attendance. Additional concerns  have been raised about the propriety of the schools’ contractual  relationships with other FFELP participants and whether these  relationships create an incentive for schools to encourage student  borrowing. In light of these issues and the pending reauthorization of the  HEA, we are providing information and analysis on three issues:  1. 	 To what extent have schools participated in FFELP as lenders and  what are their characteristics?  2. 	 How have schools structured their lending operations and what are the  benefits for schools and borrowers?  3. 	 What statutory and regulatory safeguards exist to protect the interests  of taxpayers and borrowers?
To assess the extent to which schools have participated in FFELP as  lenders, we analyzed data from Education’s information systems on school  lenders’ loan volume in each school year from 1993–1994 to 2003–2004,  which we converted to real 2003 dollars; the amount of loans made by  other FFELP lenders for students attending these schools; and  characteristics of school lenders, such as whether they are private or  public schools. On the basis of our review of the documentation for these  data and our discussions with Education officials about the steps they take  to ensure the reliability and validity of these data, we determined that the  data from these systems were sufficiently reliable for the purpose of our  study. To assess school lending operations and benefits to schools and  borrowers, we conducted site visits and interviews with 13 school lenders  and reviewed their contracts with other lenders and servicers. We also  interviewed 12 other lenders, including secondary markets; 2 state- designated guaranty agencies, which perform a variety of administrative  functions on behalf of the federal government in the FFELP; and related  higher education and financial aid associations. We also interviewed  officials of all schools that were lenders in school year 2003–2004 or  planning to lend in 2004–2005, to gather information on what type of  lender purchased their loans. To assess existing safeguards for borrowers  and taxpayers, we reviewed the HEA, related regulations, guidance issued  by Education, and court decisions. We also interviewed officials in  Education’s FSA, Office of General Counsel, Office of Inspector General,  and Office of Postsecondary Education. See appendix I for a more detailed  discussion of our scope and methodology. We conducted our work from  December 2003 to December 2004 in accordance with generally accepted  government auditing standards.
subsections: section_title: Background
paragraphs: In fiscal year 2004, students received over $84 billion in federal loans to  finance postsecondary education. The major federal loans include
Stafford subsidized and unsubsidized loans, which are available to both  undergraduate and graduate students—the federal government pays the  interest on behalf of subsidized loan borrowers while students are in  school and
Parent Loans for Undergraduate Students (PLUS), which are made to  parents on behalf of undergraduate students.
Students can also receive consolidation loans, which allow them to  combine multiple federal student loans into a single loan and to make one  monthly payment. In fiscal year 2004, about $65 billion was disbursed  through FFELP and about $19 billion was disbursed through FDLP.
Since FFELP (originally called the guaranteed student loan program) was  created in the HEA of 1965, the student loan market has changed  significantly. First, there has been a dramatic growth in student loan  volume, with more students relying on private loans, which are not part of  FFELP, than at any point in the past. Combined with the recent increases  in tuition rates and thus in the revenues generated by school tuition, this  makes the student loan market an important economic concern. Second, a  few very large lenders provide the capital for most of the loan volume.  Specifically, in fiscal year 2003, 10 lenders originated 54 percent of all  FFELP loans. Third, the creation of FDLP in 1993 and the significant  growth of private alternative nonfederal loans have increased competition  across loan programs. The primary result of this competition has been an  improvement in benefits for borrowers and of loan management in both  FFELP and FDLP, with most loans today being originated, disbursed, and  serviced electronically, according to financial aid officials.
subsections: section_title: Disbursing Loans through FFELP
paragraphs: In order to receive a Stafford loan through FFELP, students must fill out  and submit a Free Application for Federal Student Aid (FAFSA).  Additionally, parents must have their credit checked to receive a PLUS  loan. A school’s financial aid office assesses a student’s financial need and  creates a package of financial aid of grants, loans—which may include  Stafford loans—and work-study, a federal program in which students are  provided on- or off-campus jobs. Lenders provide the capital for loans to  both undergraduate and graduate students. Under the HEA, eligible FFELP  lenders include banks, postsecondary schools, credit unions, and state  nonprofit agencies. For a lender to originate a loan, the school must certify  that a student is enrolled and therefore eligible to receive a loan, and the  borrower must complete a promissory note.
After a loan is disbursed to a borrower, lenders may either service or sell  their loans. Servicing includes sending bills to borrowers and collecting  loan payments after the loan has entered repayment. Lenders may contract  with an outside organization for loan servicing. Lenders also have the  option of selling loans to a secondary market, thereby freeing up capital to  make additional student loans. To encourage lenders’ participation in  FFELP, the federal government guarantees FFELP lenders a minimum rate  of return, called the lender yield. When the interest rate paid by borrowers  is below the lender yield, the federal government makes special allowance  payments. Lenders receive these special allowance payments for loans  that they hold.
State-designated guaranty agencies, which are nonprofit organizations  designated by the state to administer FFELP loans, perform a variety of  administrative functions under the program. With federal funding,  guaranty agencies generally provide insurance to the lenders for 98  percent of the unpaid principal of defaulted loans. The guaranty agencies  also work with lenders and borrowers to prevent loan defaults and to  collect on the loans after default.
section_title: Borrower Fees, Benefits, and Payment Plans under FFELP
paragraphs: Students who borrow through FFELP may pay fees on their loans and  have a variety of repayment options from which to choose. Specifically,  students may pay a 3 percent loan origination fee and a 1 percent  guarantor fee for each loan. Lenders may pay some or all of the origination  fee to the federal government on behalf of the student, and guaranty  agencies may waive the guarantor fee. While in repayment, borrowers in  FFELP can choose from four repayment plans, including standard repayment—borrowers pay a fixed monthly amount of at least  $50 up to 10 years, graduated repayment—borrowers pay smaller monthly amounts initially  and larger amounts in later years, extended repayment—borrowers pay a fixed monthly amount that can be  repaid over a time period as long as 25 years under FFELP, and  income-sensitive repayment—borrowers pay a monthly amount that varies  according to the borrower’s income.
In addition, while students are in repayment, lenders or loan servicers may  offer interest rate reductions or cancel all or part of the loan.
section_title: FSA’s Oversight Responsibilities
paragraphs: In response to concerns about fraud, waste, and abuse associated with the  student aid programs and other management weaknesses, Congress  established FSA as the government’s first performance-based organization  in October 1998. FSA’s primary objectives are to improve the efficacy and  efficiency of student aid delivery and to make it less expensive. FSA  administers and provides oversight for all federal student aid programs,  including FFELP. Currently, FSA oversees or directly manages  approximately $320 billion in outstanding loans representing over 22  million borrowers.
FSA has 10 organizational units, 2 of which provide oversight and  guidance for schools and lenders that participate in FFELP: Application,  School Eligibility, and Delivery Services (ASEDS) and Financial Partners  Services (FPS). The ASEDS office verifies the eligibility of schools to  participate in FFELP and other federal aid programs. The FPS office  provides oversight to all guaranty agencies, lenders, and servicers to  ensure compliance with FFELP requirements.
section_title: FFELP Lending by Schools—Mostly Private Nonprofit Schools—Has Increased Significantly in the Last Five Years
paragraphs: FFELP lending by schools—chiefly private nonprofit schools providing  Stafford loans to their graduate and professional students—has increased  significantly between school years 1993–1994 and 2003–2004 rising from  $155 million to $1.5 billion. The amount of loans originated by school  lenders is likely to increase because 17 schools are in the process of  establishing their lending programs. Despite the increases in school  lending, it is still a small proportion of total FFELP loan volume. More  than three-quarters of school lenders in school year 2003–2004 were  private nonprofit schools, and all but one of them had graduate and  professional programs in law, business, medicine, or other health  specialties. Moreover, prior to becoming school lenders, several school  lenders provided loans through FDLP. Some of these school lenders  continue to participate in both FFELP and FDLP.
subsections: section_title: Between School Years 1993–1994 and 2003–2004, the Amount of Stafford and PLUS Loans Originated by School Lenders Increased by Over a Billion Dollars
paragraphs: The amount of loans originated by school lenders has increased by over a  billion dollars since school year 1993–1994, with the most significant  increases occurring in the past 5 years. Between school year 1999–2000  and 2003–2004, the amount of loans originated by school lenders has  almost tripled, from $535 million to over $1.5 billion.As shown in figure 1,  school lender loan volume has increased in each school year since 1993–  1994.
The vast majority of loans originated by school lenders are Stafford  subsidized and unsubsidized loans to graduate students—over 99 percent  of FFELP loans originated by school lenders in school year 2003–2004.  Despite limitations on lending to undergraduates, Education officials  reported that school lenders may originate PLUS loans so long as they do  so to no more than 50 percent of their undergraduates. School lenders  reported differing interpretations of the law regarding their authority to  originate PLUS loans. Some reported that they interpreted the statute to  allow school lenders to originate PLUS loans, while others—such as one  large school lender and one large secondary market—believed that they  could not. Because of this confusion, school lenders that may wish to  originate PLUS loans and could legally do so have not done so. Moreover,  school lenders currently originating PLUS loans may not be aware of the  limitations in originating such loans. Education has responded to inquiries  from school lenders that have asked for clarification on the issue but has  not issued guidance available to all school lenders. More recently, a bill  proposed by some members of Congress includes a provision that  specifies school lenders may not originate PLUS loans, unless the school  has already issued a loan to the student.
Since school year 1996–1997, the increase in loans originated by school  lenders has been due primarily to more schools participating as lenders  rather than a stable number of schools originating more loans. Several  schools we interviewed reported that a primary reason to become a  FFELP lender was to generate more revenue for the school. As shown in  figure 2, the number of school lenders increased dramatically from 19 in  school year 1999–2000 to 64 in school year 2003–2004. (See app. II for the  list of all school lenders in school year 2003–2004.) School lending likely  will continue to grow in the coming years because another 17 schools are  in the process of establishing their loan programs and preparing to  originate FFELP loans in school year 2004–2005.
Some school lenders are among the largest loan originators in FFELP. For  example, in fiscal year 2003, 14 school lenders were among the top 100  FFELP loan originators. (See app. III for the top 100 FFELP originating  lenders.) Despite the large increase in loans made by school lenders, the  proportion of total FFELP loan volume from school lenders has remained  small, rising from 2 percent in fiscal year 2000 to 3 percent in fiscal year  2003. Loans made by a school lender can, however, constitute a significant  portion of all FFELP loans to graduate students at such schools. At several  school lenders, graduate students borrowed almost exclusively from the  school. At other school lenders, the proportion of graduate students that  borrowed from the school was low—less than 10 percent.
School lenders have also made loans to not only students who attend their  school but also students who do not attend their school. Specifically, four  school lenders originated loans to students that did not attend their school  in school year 2003–2004. Officials at an osteopathic medicine school that  serves as a school lender reported that they lend to students at other  osteopathic medicine schools as a way to meet the school’s mission to  promote osteopathic medicine nationally.
section_title: Most School Lenders Are Private Nonprofit Schools That Offer Graduate or Professional Programs, And a Few Once Provided Loans Through The FDLP
paragraphs: More than three-quarters of school lenders are private nonprofit schools  representing a range of schools that offer graduate and professional  programs in law, business, medicine, or other health specialties. Of the 64  school lenders in school year 2003–2004, 53 were private nonprofit  schools, 1 was a private for-profit school, and 10 were public schools.  Private nonprofit school lenders ranged from a university with a large  student body (over 10,000 students) and graduate degree programs in law,  business, medicine, and other academic disciplines to a small specialized  school (just over 300 students) providing only a graduate degree in  chiropractic medicine. Compared with schools that were not lenders in  school year 2003–2004, school lenders were more likely to be private  nonprofits; have higher tuition costs; larger student enrollments; and offer  a law, business, or medical degree. (See table 1.)
Ten school lenders had once provided all student loans through FDLP. In  school year 2003–2004, 7 of those school lenders only offered loans  through FFELP. Another 3 school lenders have continued providing loans  through both FFELP and FDLP—the schools lend to their graduate  students, and undergraduates borrow through FDLP.
section_title: School Lenders Contract with Other FFELP Participants to Provide Student Loans and Later Sell Them to Receive Money, Which May Be Used to Lower Students’ Borrowing Costs
paragraphs: Generally school lenders contracted with other FFELP organizations to  administer their loan programs and subsequently sold their loans to  receive revenue. School lenders typically entered into contracts with other  organizations that participate in FFELP to perform key components of the  FFELP program: financing, originating (i.e., ensure that borrowers  complete promissory notes), servicing, and purchasing loans. Differences  existed in how school lenders financed and when they chose to sell their  loans. School lenders emphasized that the potential revenue received by  selling loans, which ranged from 2 to 6 percent of the total value of the  loans sold by these schools, was a significant factor in their decision to  become a lender and outweighed the costs of the program. In addition to  receiving revenue from selling loans, school lenders may also receive  borrower interest payments and special allowance payments from  Education as compensation for holding FFELP loans. Several school  lenders reported using or planning to use premium revenue to provide  borrower benefits such as reduced loan origination fees, better repayment  terms upon graduation, and need-based aid.
subsections: section_title: Typically School Lenders Contracted with Other FFELP Organizations to Administer Their Loan Program, but Differences Existed in How They Financed Loans, When They Sold Loans, and the Costs Incurred in Selling Loans
paragraphs: In order to provide FFELP loans, school lenders we interviewed generally  entered into contracts with other organizations that participate in FFELP  to perform key components of the FFELP program: financing, originating,  servicing, and purchasing loans. To select the organizations that a school  lender would use to finance, originate, service, and purchase its FFELP  loans, some school lenders asked for organizations to submit contract  proposals. For example, one school lender we interviewed specifically  asked organizations to submit proposals that included  1.  a line of credit to finance its loans with a below-market interest rate;  2.  a fixed premium for loans sold rather than one that varied;  3. 	 better financial benefits to borrowers, such as a 1.5 percent origination  4.  specifications for electronic loan processing.
These school lenders then would review the proposals and select the one  that best met the school lenders’ needs. While assessing submitted  proposals, officials from two school lenders told us that they worked with  a private company that assists schools in structuring loan programs and  negotiating the prices paid for loans. For one public school lender, the  process to review proposals was subject to the same requirements that  state agencies must follow when selecting contractors, including having  the proposals reviewed by a board that included the governor of the state  School lenders that originated loans in school year 2003–2004, or are in the  process of establishing their FFELP lending programs, contracted with  one of three types of organizations—private for-profit company, state  agency, or private nonprofit company—to purchase their loans. As shown  in figure 3, most school lenders sold their loans to private for-profit  companies.
subsections: section_title: While All School Lenders We Interviewed Contracted for the Sale of Loans, They Varied in the Extent to Which They Contracted for the Financing, Originating, and Servicing of Loans
paragraphs: The 13 school lenders we interviewed typically entered into contracts for  loan origination, servicing, and sale by selecting one organization or  multiple organizations to perform all three components. About a third of  the school lenders we interviewed used their own money to finance the  loans they made, while the others obtained a line of credit, in some cases  from the same organization that eventually purchased the loans originated  by the school lender. Some school lenders used the same organization to  finance, originate, service, and purchase their loans. Officials with one  school lender reported that contracting with one organization simplified  the loan process and was operationally efficient. Figure 4 illustrates how  one school lender we interviewed structured its program by contracting  with one organization to finance, originate, service, and purchase its loans.
In contrast, five school lenders we interviewed contracted with two or  more organizations to finance, originate, service, and purchase loans.
Figure 5 depicts how one school lender has structured its lending program  by contracting with multiple organizations. In this example, the school  received financing from a bank and loan servicing from a private nonprofit  company and eventually sold the loans to a state secondary market.
Further, one school lender we interviewed had a unique approach in how  it structured its lending program. The actual lender was a foundation  affiliated with the school because state law prohibits public schools from  incurring debt in that state. According to a school official, the foundation  finances the loans, provides them to borrowers, collects interest payments  from borrowers and special allowance payments from Education, and is  responsible for having the loans serviced until they are later sold to the  secondary market. After the foundation covers its administrative  expenses, the official stated it gives the school any remaining money. As  shown in figure 6, the foundation contracted with a secondary market, in  this example a state agency, to originate, service, guarantee, and purchase  the loans.
By and large, school lenders contracted with others to operate their  lending program, but some school lenders reported that it was beneficial  to assume financing, origination, or servicing responsibilities themselves  rather than contract with others. For example, four school lenders used  endowment or other institutional funds to finance their loans, and one  school lender’s affiliated foundation issued a taxable bond to raise the  funds needed to finance the loans. One school lender that used its own  funds also performed its own loan origination. Moreover, this school  lender performed its own servicing of the loans—monitoring student  enrollment, billing borrowers, providing periodic reports to Education,  and collecting payments for students no longer enrolled—before it sold  the loans.
section_title: School Lenders Differed in Terms of When They Sold Loans and the Costs Incurred
paragraphs: School lenders we interviewed differed in terms of when they sold their  loans, with most selling them 60 to 90 days after full disbursement, as  shown in table 2.
The decision to sell a loan can be motivated by a variety of factors.  Typically, officials from school lenders that sold the loans before 90 days  after they were fully disbursed reported doing so in part to minimize risk  associated with potential default on loans and associated servicing costs.  Moreover, some school lenders reported that they preferred to make and  sell loans within the same fiscal year so that they could repay lines of  credit to avoid having to record outstanding debt on the school’s annual  financial statements. For one school lender it was important not to record  additional debt because of concerns about the impact of such debt on the  school’s bond rating. The school lender that sold the loans a week after  first disbursement received the premium much sooner than those schools  that sold the loans after full disbursement. Two school lenders that sold  loans after the student had graduated or left the school were private  schools with sufficient resources to finance the loans and were not as  concerned about financial liability or receiving revenue quickly.
Several of the school lenders we interviewed reported that operating as a  lender was only marginally more labor intensive and costly than the  traditional processes for schools that are not FFELP lenders, and that the  premium received when loans are sold makes being a lender worthwhile.  Generally, school lenders incur initial start-up and ongoing costs when  serving as a FFELP lender. Start-up costs can include staff time to  research and sign contracts with other FFELP participants and training  staff on new software to process loans. Ongoing costs include payment of  a 0.5 percent fee to the federal government for each loan and staff to  manage the loan process and originate and service loans. The extent of  these costs borne by a school lender depended on how school lenders  negotiated their contracts, with some negotiating contracts in which they  did not have to pay for costs normally paid by FFELP lenders. For  example, school lenders we interviewed that obtained a line of credit to  finance their FFELP loans typically were charged market interest rates on  the money borrowed. However, according to one contract, the secondary  market that provided the line of credit for the school lender to finance its  loans did not charge the school lender interest. In exchange, this school  lender sold a legal interest in the loans on the day they are first disbursed,  entitling this secondary market to all principal payments, accrued interest,  government subsidies, and special allowance payments. Additionally,  several of the school lenders did not pay for loan servicing, while most  school lenders interviewed paid about $2 a month per loan for servicing.  Moreover, one school lender also told us that it receives a special rate on  private loans offered to students to supplement FFELP loans from the  purchaser because of the volume of graduate loans it sells.
section_title: Many School Lenders Reported Using or Planning to Use the Money from Selling Loans to Lower Borrowing Costs or Provide Need-Based Aid, but They Are Not Required to Do So
paragraphs: Many school lenders interviewed reported using the premium received on  the sale of the loans to lower borrowing costs and provide need-based aid  to students, although current law does not specify how premiums should  be used. The premiums that school lenders receive are based on several  factors, such as the default rate of the students attending the school, the  average amount borrowed by students, and the number of loans per  borrower. Some school lenders received a fixed premium for their loan  portfolio, while other schools were paid a variable premium that  corresponded to the average amount borrowed. For example, one school  lender’s premium increased by 0.25 percentage points for nearly all  increases of $1,000 in the average amount borrowed by students. The  premiums received by school lenders we interviewed ranged from 1.85  percent to 6 percent of the total value of the loans sold, with an average  premium of 4.4 percent.
Unlike special allowance payments and interest income that under HEA  must be used for need-based grants, school lenders may choose how they  use premiums received when selling loans. Premiums are the primary  source of revenue for many school lenders since most choose to quickly  sell loans, thereby giving up the right to receive special allowance  payments and interest income. Officials from several school lenders  emphasized that as their financial budgets have been constrained, the  revenue received from being a lender is a primary motivation for becoming  a school lender. For example, one large public school lender estimated  that it will receive about $7.5 million over a 3-year period. A smaller  private school lender estimated it will receive less than $1 million over the  next 3 years. Most of the school lenders interviewed reported that they  used or plan to use premium money for student financial aid. However,  they differed in how they allocated the money. For example, two school  lenders reported using premium revenues to pay part of the origination fee  for borrowers and generate revenue for need-based aid, while another  school lender reported using premium revenue for only need-based aid.  School lenders either used money to lower borrowing costs and/or provide  need-based grants to its students. For some school lenders, the financial  benefits offered to students who borrow through them are better than  those offered prior to the school becoming a lender.
Although most of the school lenders reported using the premium revenues  to provide financial benefits for students, under current law they could use  the money to meet other institutional needs, such as student recruitment  or facility improvement. One school lender told us that it does not plan to  use premium revenue for need-based aid but instead will use it for  initiatives that would improve students’ educational environment, such as  enhancing technological equipment. Legislation proposed in the House of  Representatives in May 2004 would require school lenders to use the  premium for need-based aid. Generally, school officials told us that the  requirement seems reasonable because most of the school lenders already  use the revenue for that purpose. According to officials from two school  lenders, they plan to use the premium for need-based aid but are still  determining specifically how the money will be allocated. One school  lender noted that the premium is applied to the school’s general operating  budget and that it is used in part for need-based aid.
The school lenders we interviewed differed in the loan origination and  guarantor fees charged to borrowers as well as repayment terms offered,  and certain school lenders offered more financial benefits to borrowers  than others. Four of the 13 school lenders we interviewed waived  origination fees for their students. Additionally, several school lenders  used guaranty agencies that did not charge or reduced the guarantor fee.  Moreover, some school lenders sold their loans to secondary markets that  offered better repayment terms than others, such as interest-rate  reductions and principal rebates for timely payments. Table 3 shows the  range of financial benefits offered to borrowers among selected school  lenders.
Officials from two school lenders stated that they contracted to sell their  loans to the agencies in their states because of the benefit programs  offered to borrowers. For example, one school lender contracted with a  state agency for the sale of its loans because the state agency agreed to  pay the origination fees for borrowers, reduce borrowers’ interest rate to 0  percent if they made the first 36 payments on time, and reduce interest  rates 0.25 percent for making payments electronically. Officials from two  state agencies that purchase loans from school lenders said they were able  to fund borrower benefits to residents of their state or students attending  schools in the state in part with earnings from loans financed with tax- exempt bonds issued by their states prior to October 1, 1993. The federal  government guarantees holders of loans financed with such bonds a  minimum 9.5 percent yield, providing these agencies a source of relatively  higher revenues in light of low current market interest rates.
section_title: A Number of Statutory and Regulatory Provisions Exist to Safeguard the Interests of Taxpayers and Borrowers, but FSA Has Not Regularly Monitored School Lenders’ Compliance with the Provisions
paragraphs: A number of statutory and regulatory provisions applicable to all lenders  and schools, and some applicable only to school lenders, exist to  safeguard the interests of taxpayers and borrowers. FSA however, has  little information on school lenders’ compliance because it has not  provided timely and adequate oversight of school lenders. Under the HEA,  lenders and schools must submit annual audits to demonstrate compliance  with laws and financial stability. Another provision in the HEA, commonly  called the anti-inducement provision, is designed to protect borrowers’  interests by prohibiting any lender from offering gifts or other incentives  to schools or individuals to secure applicants that may result in increased  student borrowing. Not only must school lenders comply with audits and  provisions of the HEA applicable to all lenders, but they must also comply  with provisions specific to them. FSA has little information about how  school lenders are complying with laws and regulations, and until this  year, FSA had not used its authority to conduct program reviews of school  lenders, which supplement the information contained in audits.
subsections: section_title: Several Statutory and Regulatory Provisions Applicable to All Lenders and Schools, and Some Applicable Only to School Lenders, Exist to Protect the Interests of Taxpayers and Borrowers
paragraphs: To protect the interests of taxpayers and borrowers, a number of statutory  and regulatory provisions exist regarding, among other things, application  processes and audit requirements for schools and lenders; these also  provide FSA and guaranty agencies the authority to review lenders and  schools. For example, in determining whether a lender will be granted a  lender identification number and permitted to provide FFELP loans,  according to HEA regulations, Education considers several factors. These  include whether the applicant is capable of implementing adequate procedures for  making, servicing, and collecting loans;  the financial resources of the applicant; and  in the case of a school that is seeking approval as a lender, its  accreditation status.
Additionally, under the HEA, all FFELP lenders that originate or hold more  than $5 million in FFELP loans must have an independent annual  compliance audit, which examines the lender’s compliance with the HEA  and relevant regulations as well as its financial management of FFELP  activities. Lenders must then submit this audit to FSA. About 17 percent of  the school lenders in school year 2003–2004 did not originate more than  $5 million and therefore were not required to have a compliance audit.  Schools that participate in federal financial aid programs must submit  audited financial statements and compliance audits that attest to their  compliance with laws and regulations governing federal financial aid  programs, including FFELP.
FSA and guaranty agencies have the authority to conduct program reviews  of lenders or schools, which are intended to assess, promote, and improve  compliance with laws and regulations and to help ensure program  integrity. Program reviews can supplement the information provided  through the required annual compliance audits. According to FSA,  program reviews of lenders tend to focus on lenders’ billing of Education  for interest and special allowance payments. FSA reviews schools that  participate in federal financial aid programs and will target schools that  have a cohort default rate in excess of 25 percent or have significant  fluctuation in Stafford loan volume from year to year. Guaranty agencies  also conduct program reviews of lenders and schools. Every 2 years  guaranty agencies must review any lender that meets one of the following  criteria:  lender’s loan volume represented 2 percent or more of the guarantor’s  volume of FFELP loans guaranteed during the preceding year,  lender was one of the guarantor’s top 10 lenders as measured by its loan  volume for the preceding year, or  lender’s loan volume during the most recent fiscal year equaled or  exceeded $10 million.
Guaranty agencies also have the authority to review any lender that has  more than $100,000 in defaulted loans and a cohort default rate above 20  percent. Guaranty agencies review schools to assess, among other things,  how schools certify loan applications and maintain loan records.
subsections: section_title: Congress Adopted the Anti- Inducement Provision to Protect Borrowers’ Interests
paragraphs: Another provision in the HEA, anti-inducement provision is designed to  protect borrowers’ interests by prohibiting any lender from offering gifts  or other incentives to schools or individuals to secure applicants that may  result in increased student borrowing. Education once attempted to  enforce the anti-inducement provision with respect to school lenders.  Specifically, Education proposed to limit the participation of a secondary  market based on its financing and purchasing contracts with a school  lender. Education contended that these contracts provided the school with  an improper financial inducement to solicit more loan applications from  students than it would have otherwise. The secondary market challenged  Education’s actions in federal district court, which found that the school  lender’s financing, servicing, and loan purchase contracts were not  uncommon among traditional FFELP lenders. Moreover, the premium paid  and other economic benefits received by the school lender were  unremarkable and did not rise to the level of an improper inducement. The  court found also that there was no evidence that borrowers were  counseled improperly or encouraged to borrow more than they needed.  Finally, while the court pointed out that under the anti-inducement  provision, lenders are prohibited from offering “inducements” to  educational institutions, including school lenders, it found that Congress’  intent was unclear. Nevertheless, the court stated that Congress did not  intend that all incentives be treated as inducements.
Since the court’s decision in this case, Education has not clarified its  definition of inducements, and according to an Education official, the  court’s decision makes it much harder for Education to show that school  lending arrangements violate the inducement provision. The lack of clarity  surrounding the issue of inducements is not solely a problem for school  lenders. In an August 2003 memo, Education’s Office of Inspector General  (OIG) noted that it had concerns about bargaining practices between  schools and lenders for private loans that students may obtain to  supplement FFELP loans and preferred lender status that may violate the  anti-inducement provision. OIG recommended that Education reevaluate  the anti-inducement provision and determine if statutory revisions should  be proposed during HEA reauthorization, but Education has not taken any  action in response to OIG’s memo. A work group representing FFELP  lenders, guaranty agencies, and financial aid officers has developed  guidelines for what constitutes an inducement, but these guidelines do not  specifically address school lenders’ contracts.
section_title: School Lenders Are Subject to a Number of Regulations
paragraphs: Not only must school lenders comply with audits and provisions  applicable to all lenders, but Congress has added provisions that apply  only to school lenders—in part to address past problems among school  lenders. In the early to mid-1970s, certain school lenders—particularly  vocational schools—did little to ensure that students paid back loans, such  as informing and counseling borrowers about repayment obligations and  options, which contributed to high default rates. Congress was also  concerned that schools were determining the cost of attendance and also  awarding students financial aid while investing few resources in  preventing loan default. While there was pressure from some groups for  Congress to eliminate the school lender provision in the 1976  reauthorization of the HEA, there were still concerns about students’  access to loans and school lenders’ roles in helping meet students’ need.  Rather than eliminating school lenders, Congress enacted and revised  several provisions designed to reduce the number of school lenders with  abusive practices that contributed to high default rates. In 1992, Congress  added another requirement specific to school lenders that they use interest  income and special allowance payments for need-based grants. Since 1992,  Congress has not added any statutory provisions regarding school lenders.  Figure 7 shows the primary statutory provisions applicable to school  lenders today that were, for the most part, enacted in the mid-1970s.
section_title: FSA Has Little Information about How School Lenders Are Complying with Laws and Regulations because It Has Not Provided Timely and Adequate Oversight of School Lenders
paragraphs: FSA has minimal information about how school lenders are complying  with laws and regulations, and until this year, FSA had not used its  authority to conduct program reviews of school lenders to assess  compliance with regulations specific to them. For example, FSA does not  check a school’s accreditation status when the school applies to be a  lender, as specified in HEA regulations. FSA was unaware that in fiscal  year 2004, one school lender who received a lender identification number,  which is needed to originate loans, had been placed on probation by its  accrediting agency. According to the accrediting agency, the school lender  was on probation because of concerns about the school’s financial  stability. In general, the lack of financial stability at a school can have a  serious impact on the funding of instructional programs, the quality of  learning resources available to students, and the number of faculty and  staff employed.
FSA is also responsible for ensuring that lenders submit required annual  compliance audits that attest to the lender’s financial stability and  compliance with laws and regulations. Compliance audits are but one  source of information about a lender’s compliance with laws and  regulations and are a mechanism to assess an organization’s internal  controls. Without these audits, Education’s ability to monitor and detect  significant fraud or other illegal acts is compromised. Compliance audits  are generally due 6 to 9 months after the end of the lender’s fiscal year. If  a lender does not submit the compliance audit, then Education may  suspend the lender’s participation in the FFELP program. For fiscal year  2002, FSA did not verify, on a timely basis, that all school lenders required  to submit compliance audits, which were due between June and August  2003, had done so. As a result, FSA did not realize, until September 2004,  that 10 of 29 school lenders had failed to submit required compliance  audits for fiscal year 2002. Moreover, while FSA had previously notified 6  of these 10 school lenders that FSA had not received the required  compliance audits, it had not yet notified the remaining 4 schools of their  failure to submit such audits. FSA subsequently reminded the 4 school  lenders to submit their required compliance audits and suspended the  remaining 6 school lenders from receiving interest and special allowance  payments for their failure to submit compliance audits. After FSA  contacted or suspended the school lenders in September 2004, 3 school  lenders subsequently submitted their fiscal year 2002 compliance audits.  FSA officials told us that school lenders required to submit compliance  audits for fiscal year 2003 had done so.
According to FSA officials, the Financial Partners office is responsible for  monitoring school lenders and may conduct program reviews to determine  compliance with regulations. FSA has not conducted such reviews of  school lenders. However, during the course of our review, three regional  offices asked 31 school lenders about their compliance with the regulation  pertaining to the use of interest income and special allowance payments  for need-based grants. The school lenders told FSA that they were in  compliance with this regulation and provided information on their  servicing costs and interest rates paid for lines of credit. FSA is planning  to conduct a more thorough review of 10 school lenders to gain a further  understanding of how school lenders are structuring their lending  programs. FSA officials reported that school lenders will be selected based  on several risk factors, such as a large increase in loan volume or an  increase in default rates. As part of these reviews, FSA will follow the  review guide used for traditional lenders, and it will also review contracts  to ensure there are no violations of the anti-inducement provision and that  fee arrangements are appropriate. However, FSA officials told us that they  had not determined the criteria for what would constitute an improper  inducement.
section_title: Conclusions
paragraphs: When FFELP was created, in 1965, Congress was concerned about  lenders’ capacity and willingness to make loans to students who had little  credit history and when the economic returns on such loans were  uncertain. Postsecondary schools were included in the definition of  eligible FFELP lenders as one way to help ensure that all students would  have access to student loans. In recent years, an increasing number of  schools are becoming FFELP lenders as a way to generate more revenue  for the school, rather than ensure students’ access to loans. As the number  of schools becoming lenders continues to increase, it is critical for FSA to  ensure school lenders’ compliance with laws and regulations designed to  ensure program integrity, thereby protecting taxpayer dollars and student  interests. For one such requirement—annual submission of compliance  audits—FSA has not ensured that school lenders have submitted them in a  timely manner. Without this information, FSA is unaware of, among other  things, whether school lenders disburse loans only to eligible students in  accordance with the law and are financially stable. A school’s financial  stability is important because if a school is unable to meet its financial  obligations, it may place into jeopardy students’ completion of their  educational programs and, in turn, their ability to repay their student  loans. Future FSA plans to review selected school lenders should provide  useful information about how school lenders operate, but without  consistent oversight, FSA may be unaware of practices that could place  taxpayer dollars at risk.
section_title: Recommendation for Executive Action
paragraphs: To ensure program integrity, we recommend that FSA’s Chief Operating  Officer take the steps necessary to ensure that school lenders are  consistently complying with statutory and regulatory provisions. As a first  step, FSA should ensure that school lenders consistently submit audited  financial statements and compliance audits in a timely manner.
section_title: Agency Comments
paragraphs: We provided Education with a copy of our draft report for review and  comment. In written comments on our draft report, Education generally  agreed with our reported findings and recommendation. Education agreed  that increased oversight is necessary given “the very substantial growth in  the number of school lenders and the loan volume associated with these  lenders.” Education stated that it believed the efforts it undertook to verify  that lenders submitted required annual compliance audits for fiscal year  2002 were instrumental in ensuring compliance and further noted that all  school lenders that were required to submit such audits for fiscal year  2003 had done so. As a result, Education noted that it believed our  “criticism that FSA has little information about how school lenders are  complying with laws and regulations is misplaced.” As we describe in our  report, compliance audits are but one source of information concerning  the extent to which school lenders comply with laws and regulations. FSA  staff could also learn about school lender compliance issues by collecting  information themselves, such as—as described in our report—determining  a school’s accreditation status when the school applies to be a lender and  by conducting program reviews. Finally, Education noted in its comments  that FSA is planning to conduct a more thorough review of 10 school  lenders. Education’s written comments appear in appendix IV.
We are sending copies of this report to the Secretary of Education,  appropriate congressional committees, and other interested parties. In  addition, the report will be available at no charge on GAO’s Web site at  http://www.gao.gov.
If you or your staff have any questions about this report, please call me on  (202) 512-8403 or Jeff Appel on (202) 512-9915. Other contacts and staff  acknowledgments are listed in appendix IV.
section_title: Appendix I: Scope and Methodology
paragraphs: To address our research objectives we analyzed data from the Department  of Education (Education); interviewed officials with school lenders,  Education, lenders, and others; and reviewed relevant laws and  regulations. To assess the extent to which schools have participated in the  Federal Family Education Loan Program (FFELP) as lenders, we obtained  a list from Education of schools approved to be FFELP lenders and then,  using data in the National Student Loan Data System (NSLDS), we  analyzed the dollar amount of FFELP loans made by each school lender in  each school year from 1993–1994 to 2003–2004. We converted loan volume  to real 2003 dollars using the Department of Commerce’s Gross Domestic  Product (GDP) Deflator and the Congressional Budget Office’s GDP  Deflator projections. We also analyzed the amount of loans made by other  FFELP lenders for students attending these schools. We used the  Integrated Postsecondary Education Data System (IPEDS) to determine  the characteristics of schools that were lenders, including whether they  were private or public schools, whether they provided graduate or  professional programs, average tuition, and average enrollment. To  identify school lenders that once provided or still participate in the FDLP,  we analyzed data on the amount of FDLP loans provided at a school  between school years 1994–1995 and 2003–2004. On the basis of our  review of the documentation for these data and our discussions with  Education officials about the steps they take to ensure the reliability and  validity of these data, we determined that the data from these systems  were sufficiently reliable for the purpose of our study.
To assess school lending operations and benefits to schools and  borrowers, we conducted site visits and interviews with 13 school lenders.  We selected school lenders that have been FFELP lenders for several  years and some that have just begun lending. Moreover, the school lenders  selected included public and private institutions, schools that had once  participated in the FDLP, and some of the largest school lenders in terms  of loan volume. We also interviewed 12 other lenders, including secondary  markets; two state-designated guaranty agencies; and related higher  education and financial aid associations. We reviewed contracts between  schools and secondary markets and servicers. To determine the types of  lenders purchasing loans from all 64 school lenders in school year 2003–  2004 and the 17 in the process of establishing their loan programs, we  interviewed officials with the school lender or with the secondary market.
To assess existing safeguards for borrowers and taxpayers, we reviewed  the Higher Education Act (HEA), related regulations, guidance issued by  Education, and court decisions. We also interviewed officials in  Education’s Office of Federal Student Aid, Office of General Counsel,  Office of Inspector General, and Office of Postsecondary Education.
section_title: Appendix II: Top 100 FFELP Originating Lenders in Fiscal Year 2003
paragraphs: Twin City Federal Savings Bank (TCF)
National Ed Loan Network (Nelnet)
Western University of Health Sciences  Security Service Federal Credit Union  CA Higher Ed Loan Authority (Chela)
section_title: Appendix III: School Lender Loan Volume in School Year 2003–2004
paragraphs: Detroit College of Law (Michigan State U.)
section_title: Appendix V: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: In addition to those named above, the following people made significant  contributions to this report: Rebecca Christie, Jeffrey W. Weinstein,  Richard Burkard, Margaret Armen, Mimi Nguyen, and Cynthia Decker.