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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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) Detroit College of Law (Michigan State U.) 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.

Summary: 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. 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.