Federal Student Loan Programs: Opportunities Exist to Improve Audit Requirements and Oversight Procedures
Released: 2010-07-21T00:00:00

Letter

Background

The FFEL and DL programs have substantially different structures but both provide student loans to help students meet the costs of obtaining a postsecondary education. FFEL loans are provided by nonfederal lenders and repayment is guaranteed by the federal government. Under the DL program, the federal government provides loans to students and their families, using federal capital. Figure 1 shows the FFEL and DL program loan volume outstanding as of September 30, 2008 and 2009.

Overview of the FFEL Program

In the FFEL program, student loans are made by nonfederal lenders, which can be for-profit or nonprofit entities. Lenders are protected against borrower defaults by federal government guarantees that are administered by guaranty agencies. Guaranty agencies are state or nonprofit entities that also perform other administrative and oversight functions under the FFEL program. For example, guaranty agencies provide counseling to borrowers regarding delinquent loan repayment and initiate collections on defaulted loans.

Generally, lenders provide the FFEL loan proceeds to a student’s school, which then credits the student’s account and disburses the residual amount, if any, to the student. Schools, lenders, and guaranty agencies often employ third-party servicers to perform functions related to the administration of the FFEL program. For example, a lender may hire a servicer to process borrower payments. Table 1 details the number of FFEL participants.

Overview of the DL Program

In the DL program, student loans are fully funded by the federal government, which provides the loan proceeds to the student’s school. The school then credits the student’s account and disburses any residual amount to the student. Schools sometimes contract with third-party servicers to assist in administering the operations of the DL program. In addition, Education contracts with a servicer (DL servicer) to administer certain aspects of the DL program, such as payment processing. The number of participants in the DL program is detailed in table 2.

Under HCERA, no new FFEL loans may be made after June 30, 2010. Borrowers who may have been eligible to obtain new FFEL loans prior to the passage of HCERA could receive loans under the DL program. Accordingly, the number of DL borrowers is expected to increase with the expansion of the program. Education has awarded contracts to four additional DL servicers to begin servicing direct loans by August 31, 2010.

Overview of Audit Guidance

Audits required under FFEL or DL are performed in accordance with guidance issued by the Office of Management and Budget (OMB) or the applicable Department of Education Office of Inspector General (OIG) audit guide. States, local government entities, and nonprofit entities are generally required to have their audits performed in accordance with OMB Circular No. A-133, Audits of States, Local Governments, and Nonprofit Institutions, although, if federal student assistance is the only federal program in which the entity participates, OMB Circular No. A-133 gives the entity the option of using the program-specific audit guide issued by the OIG in place of the guidance produced under the Circular. For-profit entities are required to have their audits performed in accordance with the applicable OIG audit guide.

FFEL and DL Audit Requirements and Oversight Procedures Generally Differed with Divergent Program Structures, and Certain Audit Guidance Was Inconsistent with Regulations

The FFEL and DL programs generally have different audit requirements stemming mainly from different program structures. The FFEL program relies on lenders, guaranty agencies, and other entities that are subject to statutory, regulatory, and contractual audit requirements. The DL program does not have as many of these audit requirements because DL loans are provided by the federal government, and fewer external entities are involved. The audit requirements set out under the FFEL and DL programs are similar with regard to schools and their servicers, which are participants in both programs. We noted that certain for-profit lender audit guidance was inconsistent with regulations. Finally, oversight procedures for the DL servicer were designed to assess the DL servicer’s performance in servicing loans in the program. Different oversight procedures are planned for four additional DL servicers expected to begin servicing direct loans by August 31, 2010.

Audit Requirements Generally Differed for the FFEL and DL Programs

The FFEL and DL programs have different statutory and regulatory requirements for audits and program reviews, with more audit requirements in place for the FFEL program, which involves more participants external to the government. For instance, because the FFEL program relies on thousands of nonprofit and for-profit lenders, there are regulatory requirements for compliance audits and program reviews of those lenders. Such requirements do not apply to the DL program, which provides student loans through a single lender—the federal government. Similarly, required agreed-upon procedures engagements for the Ensuring Continued Access to Student Loans Act (ECASLA) and audits of 9.5% Special Allowance Payments are only applicable to lenders in the FFEL program. Figure 2 summarizes the audit and review requirements for the FFEL and DL programs, and appendix I includes more details about these activities.

Both Programs Had Similarities in Audit Requirements for Schools and Their Servicers

While our analysis showed audit requirements generally differed, schools under both programs had similar requirements to have annual financial statement audits performed by independent public accountants (IPA). School financial statement audits focus on whether the financial statements are fairly presented in accordance with generally accepted accounting principles. These financial statement audits are to be performed in accordance with GAGAS. GAGAS also requires IPAs to report on the results of certain tests performed on internal controls over financial reporting and compliance with certain provisions of laws, regulations, and program requirements. Financial statement audit reports provide Education with information about the financial condition of participants, any significant internal control deficiencies, and instances of noncompliance. Third-party servicers employed by schools to aid in the administration of their federal loans are not generally required to have financial statement audits under either the FFEL or DL programs.

Both programs also require schools and school servicers to have annual compliance audits performed by IPAs. The audits focus on whether these participants comply with applicable statutes, regulations, and program requirements. For example, school compliance audits for both programs are designed to test whether schools perform student eligibility validation. These audits are to determine whether a school has verified that certain student requirements, such as citizenship and financial need, have been met. In addition, schools participating in the student loan programs are required to follow specified criteria for applying loan proceeds to students’ accounts and disbursing residual amounts to students within established time frames. To illustrate, for students borrowing from the FFEL or DL programs, schools should not credit a registered student’s account more than 10 days before the first day of classes. For both programs, compliance with these requirements is monitored through the annual compliance audit.

If performed properly, the required audits for FFEL and DL participants should address federal and borrower interests. Audits address federal fiscal interests if they are designed to help protect the government from financial loss and address borrower interests if they are designed to help ensure that qualified individuals (1) have access to federal student loans and (2) are protected from financial loss. For instance, auditors assess whether schools that participate in either program complied with refund requirements. Refund requirements for both programs include the proper return of program funds in the case of unearned tuition and other charges for a student who received federal student aid if the student did not register, dropped out, was expelled, or otherwise failed to complete the period of enrollment. Proper refunds to the lender or federal government reduce the outstanding loan amount, thus protecting federal and borrower interests.

Certain Audit Guidance for FFEL Lenders Did Not Incorporate All Requirements

As noted previously, HCERA terminated the authority to make new FFEL loans after June 30, 2010. However, FFEL loans outstanding after that date will continue under the same structure with Federal Student Aid oversight for many years, depending on the repayment plan. Accordingly, we identified and reviewed audit objectives and related guidance and found one area where the guidance for compliance audits of for-profit and nonprofit FFEL lenders differed. FFEL lenders can be for-profit or nonprofit and, in some cases, can be the schools themselves. For-profit lenders are required to have their audits performed in accordance with the OIG Lender Audit Guide. Nonprofit lenders are generally required to have their audits performed in accordance with OMB Circular No. A-133, although the Single Audit Act and OMB Circular No. A-133 allow lenders to elect to have their audits performed using the OIG audit guide if federal student assistance is the only federal program in which the lender participates. “School lenders proceeds: Determine whether schools that made FFEL loans use borrower interest payments, Education special allowance payments, interest subsidies, and any proceeds from the sale of loans to supplement needs-based grants for its students, as required.”

This audit objective is designed to assess whether school lenders appropriately comply with regulations affecting significant amounts of proceeds from loans. The OIG Lender Audit Guide has been supplemented with several amendments for specific changes to audit requirements, but has not been comprehensively updated since December 1996 and, as amended, did not address this audit objective. OIG officials told us they plan to update the OIG Lender Audit Guide to appropriately address this omission.

Education Has Designed Procedures for Oversight of the DL Servicer

The functions performed by the DL servicer are similar to certain functions performed by lenders, guaranty agencies, and their servicers in the FFEL program. The DL servicer is not required to have an independent auditor perform financial and compliance audits similar to those required of guaranty agencies, guaranty agency servicers, and lender servicers in the FFEL program. Instead, Federal Student Aid directly oversees the DL servicer’s performance as a federal contractor through monthly reviews of performance metrics as well as other procedures, including monthly reconciliations of loan balances recorded by the DL servicer to those in Federal Student Aid records. Federal Student Aid officials are to review reports generated by the Independent Quality Control Unit, a component of the DL servicer that performs analysis to help ensure that the DL servicer’s performance metrics are correctly calculated and accurately reported and that corrective actions from prior audits are implemented. These oversight procedures are designed to assess and evaluate the DL servicer’s performance in servicing loans in the DL program.

Our analysis showed that the objectives of the oversight procedures to be performed by Federal Student Aid over the DL servicer share some similarities with the objectives being addressed by audits of FFEL lenders, guaranty agencies, and their servicers. For example, both FFEL lenders and the DL servicer are to update student records to reflect changes in a student’s status—such as student enrollment, which affects the repayment of the loan. For FFEL lenders, the performance of this function is to be evaluated in the annual compliance audit of lenders performed by IPAs. For the DL servicer, this function is to be evaluated through the oversight procedures performed by Federal Student Aid staff, including monthly reviews of performance metrics that monitor the DL servicer’s performance. For example, Federal Student Aid is to monitor whether the DL servicer meets the 2-day standard for completing student status updates and the 98 percent standard for status update accuracy. Other examples of similar functions monitored by compliance audits in the FFEL program and by oversight procedures in the DL program include timely and accurate application of loan payments to borrower accounts and timely review and processing of loan discharge claims.

Different Oversight Procedures Apply to Additional DL Servicers

In 2009, Federal Student Aid awarded contracts to four additional servicers to address increased direct loan volume stemming from changed student loan market conditions and potential further volume increases. HCERA, passed in March of 2010, terminated the authority to make new FFEL loans after June 30, 2010, which, according to Federal Student Aid officials, will add substantially to Federal Student Aid’s direct loan volume and DL servicing needs. The new servicers, expected to begin servicing direct loans by August 31, 2010, are subject to oversight procedures that differ from the current DL servicer. According to Federal Student Aid’s contract monitoring plan, these activities will include transaction analysis and reconciliations as well as internal control and program compliance reviews. For example, according to the contract monitoring plan, Federal Student Aid staff are expected to perform periodic transaction analysis at the borrower account level to determine the servicing accuracy of transactions. Federal Student Aid officials and DL servicer are to discuss issues identified through transaction analysis and the status of corrective actions at weekly operational meetings. In addition, the monitoring plan states that program compliance reviews are to be conducted as needed, at least annually, to determine if servicing is in compliance with requirements. According to Federal Student Aid officials, guidance for some of these oversight procedures is under development.

The contract monitoring plan also calls for the additional DL servicers to be subject to internal control examinations performed by IPAs in accordance with Statement on Auditing Standards No. 70. Each additional DL servicer is to provide Federal Student Aid with an IPA report on the examination of its operational controls semiannually and on the examination of its information technology controls annually. These examinations are in addition to Education’s annual review of internal controls required by OMB Circular No. A-123. In addition, the contracts call for the additional DL servicers to be subject to performance measures focused on default prevention and surveys of borrower satisfaction, school satisfaction, and Federal Student Aid staff satisfaction with servicer performance. These performance measures are to be used to compare the additional DL servicers’ relative performance as one factor in determining the allocation of direct loans to them for servicing. Education officials expect to have these oversight procedures in place by the time the additional DL servicers begin servicing direct loans.

Federal Student Aid Had Policies and Procedures Designed to Monitor Audits, but Certain Audit Reports Were Not Required to Be Reviewed

FFEL and DL participants submit required audits to Federal Student Aid. Components of Federal Student Aid’s Program Compliance office, including the School Eligibility Channel and Financial Partner Eligibility and Oversight (Financial Partners) are responsible for providing oversight by ensuring that the audits performed comply with statutory and regulatory requirements. The School Eligibility Channel is responsible for providing oversight of audits of schools and school servicers that participate in the FFEL and DL programs. Financial Partners is responsible for the oversight of audits of lenders, guaranty agencies, and their servicers participating in the FFEL program. These activities are to be accomplished through audit resolution and program review processes. Figure 3 depicts the respective oversight responsibilities of the School Eligibility Channel and Financial Partners.

The School Eligibility Channel and Financial Partners are responsible for logging receipt of the audit report, performing an acceptability review, and taking steps to resolve the audit. According to policies and procedures, Federal Student Aid staff track findings contained in audit reports and use them to oversee the programs by monitoring whether corrective actions are taken. Tracking systems used by the School Eligibility Channel and Financial Partners include the Postsecondary Education Participants System (PEPS), eZ-Audit, and various Excel-based tracking sheets. Figure 4 depicts the process used by Federal Student Aid components for reviewing audit reports.

Some processes described in figure 4 are designed differently depending on the type of participant. Specifically, according to Federal Student Aid policies and procedures, schools are required to submit audit reports— both financial statement and compliance audits—to Federal Student Aid electronically via the eZ-Audit system. Other participants, including lenders, guaranty agencies, and their servicers, are expected to submit reports in paper or electronic form. For audits performed in accordance with OMB Circular No. A-133, Federal Student Aid staff are to ob tain the audit reports from the Federal Audit Clearinghouse Web site, a governmentwide audit information repository. Federal Student Aid staff are to perform acceptability reviews on the audit reports using checklist that address issues such as whether all required reporting elements are included. The School Eligibility Channel uses contractors to assist with the acceptability review of school audit reports. After the acceptability review is completed, Federal Student Aid policies and procedures require staff to review the submitted audit report and notify the participant that th e audit has been accepted or explain steps required for satisfactory audit resolution. Statutes and regulations provide authority for Federal Studen Aid to perform a program review as a method of program oversight of participants. Regulations also authorize Federal Student Aid to in administrative hearings that can lead to sanctions, including the suspension of the participant from the program. Federal Student Aid staff are to enter resolution information into eZ-Audit or PEPS once an audit is resolved. Similar processes are to be used for biennial p rogram reviews of schools and lenders performed by guaranty agencies.

Special allowance payment audits and ECASLA agreed-upon procedure reports, also required from participating lenders, are subject to similar report review procedures. Federal Student Aid procedures called for using acceptability review checklists and Excel-based tracking sheets designed specifically for these kinds of reports to ensure completeness of the reports and to track the status and ensure the resolution of reported findings. For these reports, findings resolution could include adjusting special allowance payments made to lenders or coordinating with the lender to remove ineligible loans from an ECASLA portfolio.

Financial Partners has acknowledged that inefficiencies exist with the current tracking system. For example, Financial Partners staff must manually enter the receipt of the compliance audit reports in Excel-based tracking sheets, while the receipt of the school audit reports are automatically logged through eZ-Audit electronic submission. Further, PEPS does not allow Financial Partners to readily identify those lenders required to submit annual compliance audits. Accordingly, Financial Partners staff must analyze database information to identify these lenders. Further, because PEPS does not track all audit information that is important to Financial Partners, staff supplement their use of PEPS with Excel-based tracking sheets. To address these inefficiencies, Education is in the process of designing a new system—referred to as Integrated Partner Management (IPM)—that will replace the existing systems and, among other things, provide the capability to track audit findings. According to Education officials, IPM is currently in the requirements phase, which is expected to be completed in July 2010, with implementation in phases in 2012.

Gap Noted in Receipt and Review of Certain Audit Reports

We noted a gap in Education’s policies and procedures regarding review of audited financial statements for lender servicers. Education regulations require lender servicers that participate in the FFEL program to submit audited financial statements to Education annually. However, our review found that lender servicers did not submit their audited financial statements to Education. Federal Student Aid did not have procedures in place to review these financial statement audit reports and therefore did not conduct any follow-up to ensure that the audit reports were received and reviewed. Federal Student Aid officials told us they consider the risk to the government of not receiving these servicers’ audited financial statements to be low because lenders are ultimately responsible for the loans and have the responsibility to ensure that their servicers are financially capable. By not requiring the review of the audited financial statements of lender servicers, Federal Student Aid runs the risk of missing significant findings disclosed in these reports. Such findings could relate to control weaknesses over information security and financial reporting that may not be addressed in the annual compliance audits that Federal Student Aid staff review.

Further, Federal Student Aid staff might not be informed if a lender servicer received other than an unqualified audit opinion. Concerns such as these might indicate potential problems regarding the servicer’s ability to continue program operations effectively. In addition, because one servicer may service multiple lenders, the risk to the government and borrowers increases should one of these servicers be in violation of any provision of federal regulations. According to GAO’s Internal Control Management and Evaluation Tool , agencies should obtain and report to managers any relevant external information that may affect the achievement of its missions, goals, and objectives. Unless Federal Student Aid receives and reviews these financial statement audit reports, it may not be fully aware of risks to the government and borrowers, and its ability to properly oversee the FFEL program could be impaired.

Conclusions

Significant federal resources are committed to providing loans so that students’ educational goals can be achieved. Effectively overseeing the FFEL and DL programs is critical to minimize the risks to taxpayers and borrowers. Although no new FFEL loans will be made after June 30, 2010, FFEL loans unpaid at that time will remain under Federal Student Aid’s oversight for possibly 30 years. Improvements are needed in the audit guidance and review procedures for the FFEL program. The gaps we noted in the OIG Lender Audit Guide used to audit lenders and in Federal Student Aid’s policies and procedures regarding its review of audited financial statements for lender servicers expose the program to unnecessary risk. As Education moves forward to administer the expanded DL program, maintaining and enhancing its oversight procedures will help ensure that federal and borrower interests continue to be protected.

Recommendations for Executive Action

To help address any gaps in the guidance for audits FFEL lenders perform in accordance with the OIG Lender Audit Guide, we recommend that the Education Inspector General update the OIG Lender Audit Guide to include all appropriate regulatory audit requirements.

To ensure that Education properly oversees the ongoing servicing of outstanding FFEL student loans and mitigates risks related to lender servicers, we recommend that the Secretary of Education direct the Chief Operating Officer of the Office of Federal Student Aid to develop and implement policies and procedures requiring Federal Student Aid review of audited financial statements for lender servicers.

Agency Comments and Our Evaluation

In written comments on a draft of this report, the Education Office of Inspector General and Federal Student Aid agreed with our recommendations. These comments are reprinted in their entirety in appendixes III and IV, respectively. Regarding our recommendation to update the OIG Lender Audit Guide, the Education Inspector General concurred that the guide needs to be made current with all compliance requirements and anticipates updating and issuing a revised guide by December 2010. Regarding our recommendation to develop and implement policies and procedures requiring the review of lender servicer audited financial statements, the Chief Operating Officer of Federal Student Aid acknowledged the need to update the OIG Lender Audit Guide and existing processes and procedures to require lender servicers to prepare and submit audited financial statements, and stated that Federal Student Aid will review the audited financial statements. Education also provided technical comments, which we incorporated in this report, as appropriate.

We are sending copies of this report to the Secretary of Education, the Inspector General of Education, and other interested parties. In addition, the report will be available at no charge on GAO’s Web site at http://www.gao.gov.

Please contact me on (202) 512-9095 if you or your staff have any questions about this report. Contact points for our Office of Congressional Relations and Office of Public Affairs can be found on the last page of this report. Other major contributors to this report are listed in appendix V.

Appendix I: Summary of FFEL and DL Program Audits and Reviews

The following information is from GAO, Federal Student Loans: Audits and Reviews of the Federal Family Education Loan and Federal Direct Loan Programs, GAO-09-992R (Washington D.C.: Sept. 30, 2009), enclosure, p. 16.

Appendix II: Objectives, Scope, and Methodology

To address the first objective, we reviewed our September 30, 2009, report to determine the extent to which the audit and review requirements were applicable to both the Federal Family Education Loan and the William D. Ford Federal Direct Loan (DL) program participants in order to identify similarities and differences. We obtained and reviewed relevant audit guides to determine if the audit objectives addressed statutory and regulatory requirements to be met by the programs’ participants. For the DL program, we also interviewed knowledgeable officials regarding the Department of Education’s (Education) procedures to oversee the performance of the DL servicer, and we reviewed the relevant oversight procedures. For nonprofit and for-profit schools and lenders, we analyzed Office of Management and Budget (OMB) Circular No. A-133 and the Education Office of Inspector General (OIG) audit guides to determine if they addressed similar objectives. To assess whether the audits as designed addressed federal and borrower interests, respectively, we determined if the audits are designed to help protect the government from financial loss, and help ensure that qualified individuals have access to federal student loans and are protected from financial loss. For example, we determined if the audit guides focused on determining whether the students and lenders met eligibility requirements to participate in these programs. We interviewed officials from Education’s Office of Federal Student Aid (Federal Student Aid) and the OIG, including the Acting Director of Financial Partner Eligibility and Oversight (Financial Partners), the General Manager of the School Eligibility Channel, and the Deputy Assistant Inspector General for Audit, to obtain clarification and explanations for any discrepancies identified during our review of documentation. The scope of our audit did not include testing that the audit guides were used by the auditors as intended. In addition, our work did not include program reviews conducted by guaranty agencies and other Federal Student Aid reviews because (1) in some cases, these reviews had similar objectives to the audits that we did include in our study and (2) in other cases, the reviews were risk-based and addressed specific operating conditions, and therefore these objectives were unique to each review.

To address the second objective, we focused on the design of the processes Education uses to oversee the programs and to ensure compliance with statutory and regulatory requirements for the timely submission of audit reports. We reviewed applicable statutes and regulations and Federal Student Aid policies and procedures, including process flow diagrams and audit acceptability checklists. To further our understanding of the design of Education’s processes for overseeing these programs and ensuring compliance, we observed systems demonstrations that included automated and Excel-based systems used to track receipt of audits and related findings. During these demonstrations, we observed actual steps taken by staff in order to review, and if necessary resolve, the audit. We obtained and reviewed supporting documentation referenced during these demonstrations, such as audit acceptability checklists and copies of Excel-based tracking sheets, used by staff to determine the sufficiency of the audit report’s content and to ensure the timeliness of audit submissions, respectively. We interviewed officials from Federal Student Aid and OIG, including the Acting Director of Financial Partners, the General Manager of the School Eligibility Channel, and the Deputy Assistant Inspector General for Audit, to obtain clarification and explanations for any discrepancies identified during our review of documentation and the demonstrations. We focused on describing the processes Education has designed to ensure that applicable requirements are being met. While the scope of our audit did not include testing the implementation of these processes including controls, as appropriate, we noted any design deficiencies.

We requested comments on a draft of this report from Education. We received written comments from the Education Inspector General and the Chief Operating Officer of Federal Student Aid (reprinted in their entirety in appendixes III and IV, respectively). We conducted this performance audit at Federal Student Aid offices in Washington, D.C., from August 2009 to July 2010 in accordance with GAGAS. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

Appendix III: Comments from the Department of Education Office of Inspector General

Appendix IV: Comments from the Department of Education Office of Federal Student Aid

Appendix V: GAO Contact and Staff Acknowledgments

Staff Acknowledgments

In addition to the contact named above, significant contributions to this report were made by Jack Warner (Assistant Director), Jennifer Dent, Chau Dinh, P. Barry Grinnell, and Danietta Williams. Francine DelVecchio and Jason Kirwan also made key contributions.